Investor Mistakes – Looking at Past Performance

by Investing School on April 22, 2009

At some point in our investing career, we all make the mistake of thinking about how much money we used to have. Whether it’s how much our whole account was worth or just the price of the stock when we purchased it, we let the past affect our decisions.

If at all possible, stop doing this!

How ever long the time period, the value of the investment increased when the price at the end of the measuring period is higher than the start. Therefore, if we want to increase our wealth compared with the present, we need to find an investment that goes up in price in the future. This has nothing to do with the past, nothing.

Why does this matter? Let me explain by taking a look at this example. Let’s say it was the end of 2008 when we saw Citigroup trading at $12 per share. We think “Wow, the stock was at $50 at one point. It’s so undervalued!” We then buy 1,000 shares of it and wait. As the investment community loses even more confidence, the stock goes down and trades at $1 per share. Our $12,000 investment is nearly wiped out and turns into $1,000.

Could the stock go to $50 again at some point? Of course. Will it go back up just because it was there before? Absolutely not.

Holding On For Too Long

Our luck isn’t so bad though, because Citigroup’s stock price goes back up. A couple months later, it went from $1 to $4. Since this all happened in a month, it’s a pretty extreme move. Even though we know that nothing goes up in a straight line, we are definitely holding on. We bought it at $12! It’s going to go back. It has to.

Of course, we know what happens. The stock came back down to $3 as other traders take profit, resulting in a 25% decline from $4. We could’ve sold at $4, but we let the price that we purchased at affect our judgment.

While we know that the stock price will most likely go down, we ignore it because we hope that it will go back up to the levels that we purchased it.

We know that the past has nothing to do with the present, but we always fall into this trap. By looking at the past, we are potentially:

  • Taking on More Risk – We all want to get our money back as soon as possible, so we end up buying stocks that could potentially go up the quickest.
  • Hanging Onto Losers – Anyone bought dot com stocks in 1999 and still own them? It’s safe to say that those aren’t coming back to those insanely high levels.
  • Not Making Good Use of Capital – The money that is tied up with losing stocks could be used to invest in profitable investments. The more capital is tied up with losers, the less potential you have. Think about the opportunity cost.
  • Making a Bad Investment – Most people buy investment based on the future. If you are using the past to be the judge, you are just investing incorrectly.

Forget about the past. Move on and aim for a better future.

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