How ‘falling in love’ can destroy your ASX shares portfolio

Some of the biggest dangers retail investors fall victim to are psychological traps.

That’s because investing is not just about number crunching, according to ECP Asset management investment partner Sam Byrnes.

“Investing involves both art and science. The science aspect includes analysing a company’s strategy, industry position, competitive advantage, future opportunities, and risks,” Byrnes wrote on the ECP blog.

“However, investing also involves the less tangible aspect of mitigating behavioural biases, such as confirmation bias.”

Don’t just look at opinions that agree with you

We’ve all been there. 

You are convinced that a stock is going for cheap considering its favourable thematics and outlook.

Then you see one bullish expert say the same — buy the stock now before it’s too late.

Then you see another analyst, and another, and they also talk about how great these shares are.

Well, surely you have to buy it now!

According to Byrnes, this is when investors can easily fall prey to confirmation bias.

“Confirmation bias refers to the tendency to seek out and interpret information that confirms one’s preexisting beliefs, while disregarding information that contradicts it,” he said.

“This bias can manifest as ‘falling in love’ with a particular stock, leading to over-investment without adequately assessing the risks. This can ultimately lead to significant losses.”

As well as doing proper research, it’s imperative to seek out views about the stock that are opposite to how one might be feeling.

Only listening to experts who have the same view as you can “lead to an echo chamber of ideas” and “a lack of diversity of thought”.

“To truly gain a comprehensive understanding of a company, it is beneficial to speak with individuals who hold opposing views,” said Byrne.

“Even if you do not agree with them, you will gain new insights and a greater understanding of the risks involved. This can help you to make more informed and well-rounded investment decisions.”

Stocks are not your children

Confirmation bias can also pop up for ASX shares already held in one’s portfolio.

Say a stock you bought for cheap has now climbed like you always knew it would — and now it’s a handsome three-bagger, five-bagger or ten-bagger.

You now have an emotional connection to the stock and barrack for it to go further.

But shares have no memory. The only thing that matters is the potential of the business from now onwards.

When issues arise with the business, investors that have “fallen in love” can easily ignore danger signs that may mean the original investment thesis is broken.

In such situations, what the ECP team does is to try to determine whether the problems are short-term or systemic.

“When risks are deemed to be short-term, and not a threat to long-term fundamentals, then we accumulate as the expected return increases,” said Byrne.

“However, if the risks are unknown or longer term, we exit our position or limit the weight in the portfolio until we have evidence that the thesis remains intact.”

The post How ‘falling in love’ can destroy your ASX shares portfolio appeared first on The Motley Fool Australia.

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Motley Fool contributor Tony Yoo has no position in any of the stocks mentioned. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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