Joachim Goldberg, a German behavioral finance specialist and co-author of the book "Behavioral Finance," which was first published in 1999, often warns people not to "fall in love with shares.” Women, he argues, are better investors than men, partly because they are better able to get rid of stocks (and presumably men, too) that are no longer financially worth keeping.
The love analogy is an appealing one, but more is going on here than the cliché would suggest.
Is It Really Love?
It is certainly possible to become attached to a particular stock (rather than really loving it) if what the company does and stands for is genuinely appealing. If you really like cars, you may develop a similar affection for auto stocks. Or if you think a certain company is particularly ethical, you may even love it for that, even if the numbers don’t really add up. Also, a portfolio inherited from a loved one may have true sentimental value, so you might hang on to it for emotional rather than financial reasons. As for the rest, the motives for holding on to a stock too long are many and varied.
Other Reasons People Keep Dud Stocks
The most simple reason is pure apathy. It is easier to do nothing than something, and people often just don’t bother to manage their investments. Brokers may not bother either, and there is certainly no love involved in such a situation, neither of the stock nor of the client.
A desire to avoid taking a loss is another classic reason. It is human nature to hope that one will at least get back the purchase price, but this often won’t happen, or it would take so long that the opportunity cost is enormous. It is financially better to cut one’s losses.
Then there is greed. If you have made a 100% profit, you may think you can double your money again or even more. This may or may not be greed. After all, there is nothing to stop the stock from going up another 500% if the company and the markets play along. Is this really greed or economic rationality and simple risk-friendliness? A desire to earn as much money as possible from an investment is not in itself greed. It is only when such a desire is or becomes excessive, leading to irrationally holding the stock for far too long, that greed has taken over. But it isn't always easy to know when the time has come to part company, just as in human relationships.
In line with the above point, uncertainly about the future is also relevant and all-pervasive. There is that old saying that “no one ever went broke from taking a profit.” On the other hand, it is upsetting when the profit could have been 10 times higher. Cutting a stock loose at the first sign of trouble can lead to serious regrets. Again, whether hanging in there waiting for the big payoff is really greedy or imprudent is subjective and even depends partly on luck. Perhaps one should at least “take some money off the table,” but not all. Who knows for sure?
The Impact of All This On the Market
Of particular importance is the fact that if a stock is “everyone’s darling,” this passion may be justified simply by the pressure it applies on the price from all those admirers. Journalists tend to warn that “your stocks won’t love you back,” but if everyone else loves them, they can. Such sentiments may result in an intrinsically unsound stock not declining in market value, or at least not as much as the inherent value of the underlying company would suggest. Psychology plays an enormous role in the financial markets, both on the seller and buyer sides. When enough people cling to suboptimal investments, this impacts market performance and returns.
Generally speaking, it is financially imprudent to keep stocks for any reason other than that they are likely to bring a good return in the future.
There are, however, many reasons why people keep stocks that, objectively speaking, they should sell. One of these reasons is the notorious “falling in love” phenomenon, but the prevalence of this phenomenon is probably overstated. People may keep a dud stock out of apathy, greed, ignorance, going with the masses or because they inherited it from their dad. Or they may be perfectly willing to take a risky punt. Furthermore, if a stock is loved enough by enough people, that will prop up the price.