I always get this question from clients whether should they convert their USD or GBP (or whatever foreign currencies) to SGD (or to other currencies). Similarly, I am always asked whether should they sell their stocks to buy something else. The same applies to properties.
On the surface, these questions appear to be legitimate. But in reality, these clients were expressing irrationale investment behaviour.
Normally these questions arise because of their inability to come to terms with losses made. For example, they may have bought the USD when it was 1.4 but now it has dropped to 1.37. Or they bought Noble Shares at 3.21 but now it sank to 0.625. Due to the losses made, they will make some irrationale decisions.
Hold on to the investments hoping to breakeven
Very often, such clients want to hold on to their investments in hope to breakeven.
First, such thinking actually assumes that the investment is like a human. If a guy expresses his love and patiently wait for the girl to reciprocate, there is a chance that the guy’s patience will pay off. However, investments are unlike a relationship between two lovers. Investors who hope to breakeven is going to be disappointed as their investments do not reciprocate like humans. As the saying goes, never ever fall in love with your investments.
Second, the breakeven price is highly dependent on when the buyer bought the investment. The assumption is that there is a chance that the investment will rise to the buyer’s purchase price. But this thinking is flawed as the investment does not know the buyer. In fact, there are huge number of buyers in the market each with a different purchase price. On what basis will the investment rise to the specific buyer’s price? A more logical way is to use technical analysis (TA) to determine the buy/sell entry prices. TA uses past trends to make decisions although its usefulness is debatable.
Third, holding on to the investment could potentially increase the risk of the portfolio. For example, if the stock price has plunged by 90%, it could very well be due to the increase in risk of the investment. That is why the price is so low. So continuously holding to the investments increases the risk! A rationale investor controls the risk of his portfolio and never allows it to increase beyond his risk tolerance.
What would a rationale investor do? A rationale investor will decide to hold or sell the existing investments based on the future prospects of the existing investments while he ignores the purchase price because the purchase price is a historical event that is irrelevant.
Buying investments of the same currency
Very often, I will encounter clients who wants to invest using their foreign currencies but they will not allow me to convert their currencies. So they will tell me that they only want to invest in funds that are of the same currencies. However, as a professional financial planner, I always invest clients’ monies in a diversified portfolio. With such diversification, it means that the underlying currencies are diversified. Thus, they would have to convert their currencies anyway.
To understand why the reporting currency of a fund is not important, please read interesting article: Currency effects of ETFs and Unit trusts .
By the way, when you buy stocks in say foreign currencies, it does not mean you did not ‘convert’ your currency. Many of such stocks have international exposure and hence their profitability is dependent on their international operations and hence are exposed to multiple currencies.
Failure to take into the account of opportunity cost
The opportunity cost is if you hold on to your investments while missing out a better alternative
Let’s say you make a loss of -20% investing in X. Assuming the purchase price was $1. The opportunity cost of holding on to X is Y which can give you 10% per annum. The breakeven price is not $1 for X. Let’s say your waiting period is 5 years, then the breakeven price for X has to be $0.80 * 1.105 = $1.288. Hence, X has to appreciate by 1.288/0.8= 61% just to breakeven. But if you think about it, this is nonsense. X and Y are entirely not the same thing. How can X and Y have the same future return? But nonsensical reasoning is the result of an irationale investor who is fixated at waiting for X to reach the breakeven price to happen before selling.
Hold on to the investments to enjoy the gain
Another reason why many investors refuse to sell their investments is because they are holding to their gains. People do not wish to sell their profitable investments because they want to enjoy the gain and hope to make more money.
Once again, holding on to their profitable investments is not logical because (1) the decision to hold or sell should be based on future prospect of the investments, not the past purchase price (2) The historical purchase price is irrelevant (3) it is important to evaluate any other opportunity cost of holding to the investments (4) and holding on to the investment potentially is increasing the risk level of the portfolio – as the prices go higher, the chance of collapsing is higher too.
Once the prices drop, investors will have to continue to hold on to their investments hoping to breakeven. So we are back to the square one.
If you are still confused, just remember that whatever what you did in the past and the price you paid for your investment is totally irrelevant. Similarly, it is not relevant what was the exchange rate of the currency you changed previously. What is important is the future.
Given that 90% of investors are irrational, 10% will make lots of money from the remaining 90% who will lose a lot of money. The question is whether are you the 10% or 90%?
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