We all know what an acute disease is. You might have to take a few days off work or even go to hospital. More problematical are chronic diseases. They tend to creep up on you so that you are not really sure how to describe the symptoms. Perhaps you feel a bit low, not the energy that you used to have. It is the same in the share market. Acute diseases are very clear. They are when you invest in companies such as Enron or Citigroup in the USA. Or HIH or ABC Learning Centres in Australia. However, it is the chronic diseases that can play havoc with your investment health year upon year. An outcome of chronic investor diseases are that, no matter what you do, the results of your investing activities are mediocre at best with the whole process of investing becoming increasingly stressful. In the end you begin thinking that investing in stocks is not for you. You start thinking about putting your money in investments that supply a fixed interest rate or handing your money over to a financial planner.

Over the years I have studied the symptoms of chronic investor diseases; in this article I will describe three that are particularly damaging. The first is get-evenitis. This is the disease of hanging on to losers, shares that have dropped in price, and not selling until you can get your money back.

If you buy XYZ for $20 and it drops to $12, you now own a $12 stock. It does not matter how it arrived at this price. The question now becomes, “If I had $12, would I buy a unit of XYZ or would I buy something else?” If the answer is to buy XYZ, then hang on to it. Otherwise consider selling it. The only thing that is important is getting maximum profit on the $12 from this point onwards. The past is the past. Unfortunately our ego will goad us into all sorts of rationalisations why we should not sell at a loss. Just as in real life, sometimes we have to face our mistakes and accept a loss before we can move on.

Get-evenitis has an associated disease called consolidatus profitus. Where you see one, you usually see the other. Sufferers of consolidatus profitus are often heard intoning “You can’t lose money by taking a profit.”

You may not lose money for that particular stock, but in the end what makes the difference is what we do with our profits. What if we put the money from the sale into a stock that is a major underperformer? We may be able to say that we made a profit on a particular stock. What we are not saying is that our portfolio went down because of the way we spent the profits.

If ABC goes from $20 to $30, then you now own a $30 stock. In the same way that you examined the losers above, think what you would do with $30. If you would buy ABC for $30, then keep the stock. If not, then consider selling it.

Of course, in real life things are a bit more complicated since we have to take into account transaction costs and taxes. But I think the general idea is clear ? evaluate your stocks on what return you expect to get from them in the future, not on what they have done in the past

Evaluate your stocks on what return you expect to get from them in the future, not on what they have done in the past

Just how wide-spread are these diseases follows from a large-scale study carried out by Terrance Odean of the University of California in Davis. Reporting in the Journal of Finance, 1998, he found that people tended to trade out of winners into stocks that performed less well. Overall he found that people would have been better to sell their losers and keep their winners. Instead, they did the opposite, namely keep their losers and sell their winners.

The difference between the two strategies is even more marked when taxes are taken into account. When you claim a loss you are getting a tax rebate and so you want this as early as possible. In contrast, with a profit you are paying tax so you want to delay this as long as possible. But, as we just learned, the average investor tends to take profits early and losses late ending up on the wrong side of the tax office.

Another prevalent chronic disease I call tradophilia, the love of trading. Odean carried out another study to see who were the better investors, men or women. He found that the women outperformed the men. But ladies, before you start congratulating yourself on your superior intelligence and analytical abilities, we need to look at why your sex did better. The reason is that, as a group, you traded less. Many studies have shown that the more often a person buys and sells stocks, on the average their performance goes down.

How do you cure chronic investor diseases? Just like regular chronic diseases, you need to diagnose them, treat the specific disease, and then strengthen the (investor) immune system so that they don’t return.

The most important step is to perform an honest analysis of your portfolio … and of yourself. Imagine that all the shares in your portfolio that have gone down in price were suddenly turned into their cash values. Would you buy the same shares again, or would you more likely put the money into different shares. If the latter, you may well be suffering from get-evenitis, the belief that you should always hold on to a stock if the price goes down.

The most important step is to perform an honest analysis of your portfolio … and of yourself.

Now look at the recent sales you made? Did you sell simply to take a profit? What did you do with the money? Have you made more money with it since the sale? Or would it have been better to have left it where it was. If this is the case, you may be suffering from consolidatus profitus, the chronic disease of always wanting to sell shares when their price goes up.

Conscious Investor provides a rigorous analysis of all companies so that you are less likely to be pulled down by chronic investor diseases such as those described above or others that I have identified. It builds up the investment immune system to protect against them.