If you had bought shares of MRF in 2009, you would have made a fortune today. Imagine how much more you would be worth if, along with MRF, you also had some shares of Berkshire Hathaway! Articles that state how much wealth you would have had if you had bought and held shares of such companies, are interesting to read. But how many mass-affluent individuals you know have actually accumulated large wealth by holding such shares? In this article, we discuss, using behavioural psychology, why it will be difficult for you to buy and hold shares for long periods of time.

Picture this. You receive a gift of ₹10,000 from a friend. Let us suppose you derive 100 happiness points from this gift. Later that evening, you realise you have lost ₹10,000 during grocery shopping. How much pain do you think you will suffer? Will it be minus 100 happiness points? No. You are likely to experience minus 200 happiness points. That is, the pain you experience due to a loss is likely to be twice as much as the happiness you derive from a gain of the same magnitude.

Loss aversion

Behavioural psychologists attribute this phenomenon to our tendency to hate losses more than we like gains of the same magnitude. This phenomenon is called ‘loss aversion’. And because you hate losses more than you like gains, you are likely to take more risk to avoid losses and less risk when you have unrealised gains.

Suppose you buy a stock at 100. If it declines to 80, you are more likely to hold the stock because you hate to take losses. In the process, you are assuming more risk, for the stock can decline further. If the stock instead moves up to 120, you are more likely to take profits, fearing the stock could decline, wiping out your unrealised gains. Therefore, you are risk-seeking when you face gains and risk-averse when you experience losses.

This brings us to the reason why you are unlikely to hold on to stocks such as MRF for a long time. Because of your aversion to losses, you are more likely to take profits too soon and hold on to your losses for too long. So how then can you get rich buying shares such as MRF?

Rule-based approach

Before we discuss further, note that your core portfolio should preferably consist of equity funds. It is your satellite portfolio that should have individual stocks. But you are unlikely to hold such stocks for a long period of time, for the very strategy is to trade actively — that is, buy, hold for a short period and then sell.

So it is moot if you would have held MRF at around 9,500 levels in 2010 had you bought the stock at around 1,500 levels in 2009. And if you are not a professional trader, it is even more questionable if you would have bought the stock again at 30,000 in 2016.

It is indeed nice to read articles that tell you how much you would be worth if you had bought and held shares of certain companies. The point is: you are unlikely to hold on to a stock for a long time if you have unrealised gains.

And if you do, it could be more by coincidence than by design. For one, you could have inherited such shares. For another, you could have forgotten that you bought these shares long ago until you read about the company in the newspapers. But how often is that likely to happen in the current technology-driven world where your portfolio value is updated in real time?

The author is the founder of Navera Consulting. Send your queries to portfolioideas@thehindu .co.in

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