How many times have you heard envious examples along the lines of ‘if you had bought $1,000 worth of Amazon shares at IPO in 1997, your investment would now be worth $1.2m!’, or ‘if you had bought ten shares of Microsoft, worth $210 at IPO in 1986, they would have ballooned to a value of $3.1m today!’[1]?

There’s no arguing that these are exceptional returns, but hindsight is a wonderful thing. How many investors would have had the nerves of steel to last through the ups and downs? The reality is, most, if not all investors would have been shaken off the ride by selling too early.

And unfortunately, the reverse doesn’t hold: investors tend to hold on to the losing positions for too long, even if they’re aware the price is likely to continue falling.

That’s because all humans suffer from psychological biases; the one described above is termed the ‘disposition effect’ where investors tend to sell winners too early and hold on to losers too long – the worst of both worlds. Terrance Odean, found a clear tendency for this after studying 10,000 accounts held at an American discount broker between 1987 and 1993. What’s more, there was no good reason for it – on average, after one year, the losing stock that investors held, fell by 1.0% against the market. While the winning stock that investors sold, outperformed the market by 2.4%.

There are several academic suggestions to explain why this may occur:

Loss Aversion:

A loss hurts far more than the pleasure derived from a gain of equal value. Because we’re so averse to losses, we’re willing to take on additional risk to avoid it (i.e. continuing to hold the losers) even though we may gain more from redeploying those funds elsewhere. When faced with a gain, we prefer the less risky option (i.e. lock in profits by selling the winners) despite the future potential.

We dislike losses more than we like gains

Image: Illustration of Loss Aversion. Tversky, A. & Kahneman, D., 1981, The framing of decisions and the psychology of choice. Science, 211, 453-458.


Our brains tend to anchor to the first piece of information we encounter, even if the information is irrelevant to the decision we need to make. In investing, the historical purchase price acts as an anchor – we dislike selling below this price – even though our decision should be based on future prospects of the company.

Regret Theory:

Emotions, regret and pride in particular, kick into action once a gain or loss is crystallised. We hold on to a losing position in the hope it will recover and we can avoid the feeling of regret for our past decision. Conversely, we sell a winning position too quickly to hasten the feeling of pride at having chosen correctly.

Who is impacted by the disposition effect? The short answer is, everyone. However, a number of studies have found that the disposition effect is stronger for retail investors than for institutional investors. Chen, Kim, Nofsinger, and Rui (2007) analysed 50,000 Chinese investors from 1998 to 2002 and found that investors were 67% more likely to sell a winner than a loser. However, a subsample of 212 institutional investors showed a much weaker disposition effect as they were only 15% more likely to sell a winner[2].

There’s no sure way to eliminate these psychological biases, but there are ways to minimise the impacts they can have on our investments:

  • Education and awareness can help us to avoid common pitfalls. Recently, a number of the Milford team attended a presentation by Tobias Moskowitz, an esteemed academic in the field of behavioural finance, which was a healthy reminder to us all not to disregard our innate psychological biases.
  • Our investment process identifies best-in-class companies, often with significant runways for growth and sustainable competitive advantages. Maintaining a long-term view can give us more confidence in our decision to hold on to our winners.
  • Every day, the decision to buy, hold or sell should be an independent decision about the future. The Milford Global Equity team conduct a ‘blank slate’ exercise regularly as part of the investment process where each team member puts forward their best ideas, without regard for current portfolio holdings (eliminating this anchoring bias). Companies that do not receive a mention are ‘available for sale’.
  • Playing devil’s advocate: analysing both the bull and bear case for a company ensures we look at both sides of the coin. Our investment team of 23 means there is never a lack of healthy debate and discussion. Given how difficult it is to self-manage biases, the team also plays an important monitoring role.

Of course, being aware of these biases and believing we have them under control may contribute to yet another bias… the overconfidence bias! Being disciplined and humble when making investment decisions can help keep this bias in check.