I regularly receive emails from people who tell me that they have been following some investment methodology, such as buy and hold, have recently lost a lot of money, have found our newsletters, want to follow our newsletter, but are afraid. (Boy, was that a mouthful. )

They are afraid that by switching out of their losing investments, they will “lock in” their losses. They feel that, while they have lost money, those are “paper losses”. But once they switch out of the losing funds and start following our newsletters, they will somehow make those losses more real.

I think that many people get confused for the following reason. They see a fund that has lost a large amount of money fairly quickly, so they reason that it should regain that money just as quickly. They are afraid to get out of the fund because they are afraid to miss this big up move.

The reality is that a big loss in the recent past does not imply a big gain in the near future. The false belief that this implication exists is an example of a cognitive bias called the gambler’s fallacy. Someone who commits gambler’s fallacy thinks that returns are negatively autocorrelated, that is, that negative returns are typically followed by positive returns. However, returns are not autocorrelated, either negatively or positively.

This incorrect belief is why people are afraid of “locking in” their losses. They are afraid to miss the big up move which, they believe, is imminent. However, there is simply no evidence that returns behave in this way.

Related posts:

1. Accumulating shares and paper losses
2. Focus on return and risk, not price; losses are locked in as they occur
3. Switching to this newsletter
4. Bonds strengthen, stock “rally” not proven
5. Selling off stocks when they’re down

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