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Also, why is it that many people have outstanding credit card balances, yet claim they are saving money because they put £50 per month into a high interest building society account? If that's you -- wake up! The credit card company will be rubbing their hands with glee as you pay them upwards of 15% per annum on your outstanding balance. Meanwhile, your high interest savings account is paying you the princely sum of 6% per annum. You think you're saving, but you're losing money.
People do that because they compartmentalise their money. They force themselves to think of money in different ways, regardless of the irrationality of the situation. As so aptly described above.
If you found £50 in the street, would you behave differently with that £50 to the way you would with £50 out of your wage packet? Most people would be more willing to spend the £50 found in the street -- either as a treat to themselves, or someone else, or perhaps they'd be willing to gamble it on the horses or the lottery. But why act differently with that £50? Because you've compartmentalised it. At the end of the day, it doesn't matter where that £50 has come from. Think of it as £50 and not as £50 you were lucky enough to find.
Because, if you don't, when you make some money out of buying shares, the chances are that you'll think of that as 'won' money. That increases your chances of blowing that particular money on something frivolous -- maybe a few magnums of champagne, a holiday that you don't really need or want, or a new red sports car. You forget that investing in the stock market is a business.
You also forget about the power of compounding returns. In the early years, if you take money out of your business -- in this case, that of investing in the stock market -- your returns will suffer in the latter years. £10,000 growing at 10% per annum is worth almost £175,000 after 30 years. Not bad going, as you've made almost £165,000. But, if you let than money run for another 10 years, in that time you'll earn another £278,000!
Again...
30 years for £165,000.
The next 10 years for £278,000.
Never underestimate the power of compounding returns.
Now I'm not advocating that you never spend your money on things like a sports car and a holiday. We've all got to enjoy life, and you can't take your money with you when you finally kick the bucket. But, when we do spend it, we've got to do it rationally. The scenario above was not rational, because you were spending what you perceived to be 'won' money. If on the other hand you were making a business decision, and came to the conclusion that you wanted, and could afford, a new sports car, you should go ahead and buy it, regardless of which compartment that money came from.
I'll leave this week's psychology lesson with a quote from the same book.
"...people feel more strongly about the pain that comes with loss than they do about the pleasure that comes with an equal gain."
That goes a long way to explaining why people hang on to their losing investments for far longer than they should. The pain of selling, which crystalises the loss in investor's minds, is too great. Yet many of those same people are all too quick to sell a winning investment, because "you can't lose taking a profit". Well, you may not lose, but you may miss out on a hell of a lot of upside if you're too eager to sell.
It's simple really -- run your profits and cut your losses. Unfortunately for most of us it's much easier said than done.
Qualiport Candidates
Maynard and James have been busy putting forward some very interesting potential candidates for the Qualiport. We'll soon be sitting on almost £4000 cash, and that's money we want to invest in the market, but only when we feel right about a company.
Of the companies suggested, I'd concur with quite a few of the Qualiport discussion board posters that MMT Computing (LSE: MMT) potentially looks the most attractive. Unfortunately there's no perfect company, so it will undoubtedly have its faults. But, if we decide to go for it, we'll make sure we've got a sufficient margin of safety in the valuation so as any downside is limited.
Minimise the downside. That's something I've been guilty of not doing in the past.
Finally...
I couldn't help but notice the recent share price rise in Dell Computer Corporation (Nasdaq: DELL). The Qualiport is now in the black on that particular investment, having been down the gurgler to the tune of almost 30% not too long ago. Am I guilty of only singing when we're winning? You betcha. Of course, over the very long term the share price will track the performance of the underlying company -- higher, lower or nowhere, as the case maybe. It's still early days yet as far as the success or not of our investment in Dell is concerned.
Have a great weekend. I'm off to the beach! See you next week on the Qualiport discussion board.
Related Links
• The Qualiport candidates
• Compounding returns
• How To Value Shares
• Minimise the Downside
Note
The Qualiport was launched on December 19th 1997 with an initial investment of £4040.63, all in Rentokil Initial. Further cash was added as holdings in Emap, Marks & Spencer and Unilever were bought during 1998. The vagaries of the value per share accounting method caused percentage return calculations for calendar 1998 to be somewhat distorted. To avoid confusion and somewhat misleading figures, the Qualiport's returns are being measured from 1/1/99, at which point the total portfolio value, including cash, stood at £16,809.60. An additional £2000 cash is added to the portfolio on April 1st and October 1st each year. The total cash investment in the portfolio to date has been £20,184.62. To access the Qualiport's total trade history, click here.