IC:Exactly. Often the reference point is the purchase price that investors
pay for the stock. Investors become fixated on this reference point to the
exclusion of any other information. Richard Thaler from the University
of Chicago, who has done seminal work in investor behavior, refers to
this as mental accounting.^18
When you buy a stock, you open a mental account with the pur-
chase price as the reference point. Similarly, when you buy a group of
stocks together, you will either think of the stocks individually or you
may aggregate the accounts together.^19 Whether your stocks are showing
a gain or loss will influence your decision to hold or sell the stock. More-
over, in accounts with multiple losses, you are likely to aggregate indi-
vidual losses together because thinking about one big loss is an easier
pill for you to swallow than thinking of many smaller losses. Avoiding
the realization of losses becomes the primary goal of many investors.
Dave:You’re right. The thought of realizing those losses on my technol-
ogy stocks petrified me.
IC:That is a completely natural reaction. Your pride is one of the main
reasons why you avoided selling at a loss. Every investment involves an
emotional as well as financial commitment that makes it hard to evalu-
ate objectively. You felt good that you sold out of your Internet stocks
with a small gain, but the networking stocks you subsequently bought
never showed a gain. Even as prospects dimmed, you not only hung on
to those stocks but bought more, hoping against hope that they would
recover.
Prospect theory predicts that many investors will do as you did—
increase your position, and consequently your risk, in an attempt to get
even.^20
Dave:Yes. I thought that buying more stock would increase my chances
of recouping my losses.
IC:You and millions of other investors. In 1982, Leroy Gross wrote a
manual for stockbrokers in which he called this phenomenon the “get-
even-itis disease.”^21 He claimed get-even-itis has probably caused more
destruction to portfolios than any other mistake.CHAPTER 19 Behavioral Finance and the Psychology of Investing 329
(^18) Richard Thaler, “Mental Accounting and Consumer Choice,” Marketing Science, vol. 4, no. 3 (Sum-
mer 1985), pp. 199–214.
(^19) Richard H Thaler, “Mental Accounting Matters,” Journal of Behavioral Decision Making, vol. 12
(1999), pp. 183–206.
(^20) Hersh Shefrin and Meir Statman, “The Disposition to Sell Winners Too Early and Ride Losers Too
Long: Theory and Evidence,” Journal of Finance, vol. 40, no. 3 (1985), pp. 777–792.
(^21) Leroy Gross, The Art of Selling Intangibles, New York: New York Institute of Finance, 1982.