Updates from Chicago Booth

Lost money? Reinvest!
By Erik Kobayashi-Solomon – Investors sometimes play a psychological trick on themselves when they lose money, research suggests—and that mental accounting trick may help improve their investment performance.

According to Cary D. Frydman and David H. Solomon at the University of Southern California and Chicago Booth’s Samuel Hartzmark, investors who sell a losing investment often avoid the psychological pain by immediately reinvesting in another stock. By doing so, instead of thinking of the action as realizing a loss, they frame it as rolling capital into a related investment. The reference point used to compute gains and losses is linked to the amount paid for the original asset.

That mental accounting trick may help them avoid an often-made mistake. A key insight of behavioral finance is that investors, to avoid the pain of realizing a loss, fall prey to the disposition effect: they tend to be more likely to sell winners than losers. But the act of reinvesting makes investors more willing to sell a losing stock and realize a loss sooner. more>

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