DIY Investor Diary: this rule takes the emotion out of investment decisions

In the next instalment of our DIY Investor Diary series, Kyle Caldwell speaks to an investor who has a strict discipline of taking profits and cutting losses.

20th February 2024

by Kyle Caldwell from interactive investor

One investment pitfall is becoming too emotionally attached to a share, fund or investment trust whether it is a winner or a loser.

For the winners, investors risk becoming complacent having potentially “fallen in love” with the returns made in the past. However, there is no guarantee a top-performing company or fund will continue making hay in future years.

It’s important to take a step back and assess why an investment winner has been performing well. A fund, for example, could have been boosted by the region, area of the market, or investment style being in favour, which may not persist indefinitely.

In a similar vein, many investors find it hard to cut losses when an investment is underperforming. Some of this is rooted in behavioural finance biases, which cause investors to make irrational decisions based on emotion. Inertia, a tendency to maintain the status quo, is one example of a behavioural bias that can affect investment decisions. Inertia is part of the “endowment effect”, where an investor puts a higher value on something they own, so they are more reluctant to sell.

The latest interactive investor customer to feature in our DIY Investor Diary series seeks to take the emotion out of investing by enforcing a strict discipline of applying a “stop loss” of 15%.

The investor, who prior to retirement was a financial adviser, explains: “If, for example, I buy something at £1, I will sell it if it drops to 85p. Conversely, if it hits £1.50 and drops 15% from its all-time high, then I will also sell it if it falls to £1.27.”

To keep track of how his investments are faring, the investor has created a spreadsheet. He says: “I record the date of purchase, the epic (a shortcut for the name of the investment) buy price, current price, highest price ever achieved, present percentage gain or loss, the highest percentage gain, and finally the date it happened.”

He is a very active trader and a follower of the momentum style of investing.

Momentum investing is a strategy that taps into investors’ psychology. Some investors will refuse to buy a particular share or fund until they see an uptick in performance, as they want their inclination to buy to be validated by the market as a whole. Then, if that company or fund starts to rise decisively, investors who initially sat on the sidelines start to fear missing out on an opportunity to make money. They then buy, leading to momentum being retained.

However, this approach is only for those with the time and dedication to keep on top of their investments on a daily basis. Moreover, trading frequently can eat into overall returns.

The investor says: “I am a believer in momentum. I am trying to catch a wave and find investments that are starting to have a good run of performance. I study performance figures over one, three and six months, look at which shares, funds and investment trusts are starting to move, and consider the reasons why they are going up.”

He has both a self-invested personal pension (SIPP) and a stocks and shares ISA. The SIPP holds a mixture of shares, funds and investment trusts, while the ISA contains AIM shares that typically qualify for Business Property Relief. Such shares are exempt from inheritance tax (IHT) if they’ve been held for more than two years. The plan is for both the pension and the AIM ISA to be gifted to his four children.

In the SIPP, the six funds held are Comgest Growth America, L&G Global Technology Index, TM Natixis Loomis Sayles US Equity Leaders, Nomura Funds Japan Strategic Value, Pictet Robotics and GAM Disruptive Growth. The latter two are new holdings, introduced at the start of 2024.

Three investment trusts are held at present. 

3i Group Ord 

Ashoka India Equity Investment Ord 

 and India Capital Growth Ord IGC1.14%.

Despite currently holding fewer trusts than funds, the investor says he favours investment trusts due to their structural differences.

He says: “Investment trusts have a board of directors who can, and have, taken the investment mandate from an investment company and awarded it to another if they feel that there is underperformance or poor management.

“As regards dividends, they can withhold income and carry it forward to the next year, something that their collective cousins can’t do. Often it is possible to buy the investment trust at a discount to its net asset value. Again, this is something denied to funds.

“[Trusts] can gear (borrow) to magnify returns, but this can work against them in falling markets.

“Finally, you can deal instantly, whereas prices change only once a day with funds. If the market is either falling or rising rapidly, you have to wait until the following day to deal in funds, by which time prices may have moved badly against you.”

In addition, some exchange-traded funds (ETFs) are owned, including 

Amundi IS Nasdaq-100 ETF-C USD GBP 

Amundi Russell 1000 Growth ETF, 

Invesco EQQQ NASDAQ-100 ETF GBP  

Invesco Technology S&P US Sel Sec ETF GBP  

iShares S&P 500 Info Tech Sect ETF$Acc GBP 

IITU0 and ETC Group Global Metaverse ETF.

Given the yearly fund charge for passive funds is much lower than active funds, our DIY Investor says he’s drawn to passive strategies in areas that are heavily researched, meaning it is harder for active fund managers to gain an edge.

He says: “It has to be a special actively managed fund to get my attention.”

Key lessons learnt over the years include being both patient and humble. He notes: “One of my mottos is that success or failure in life is never final. It’s very chastening because it stops you from becoming complacent if things are going well, and it’s uplifting that even if things are bad, [things] can and will change. 

“When applied to investment, don’t get cocky just because your investments seem to be flourishing, and don’t despair if they are suffering. Nothing lasts forever. Most investments enjoy a hot spell, but they can also endure lean times.

“Just to emphasise the point, when practising as an Independent Financial Adviser I had several “bankers” such as Lindsell Train Ord  Worldwide Healthcare Ord and TR Property Ord TRY but in the six years since I retired they have gone nowhere.

“Investments are only a vehicle or means to an end, so don’t get emotionally attached to them. Some people can’t sell even when something is floundering because it would confirm that their judgement might have been wrong. I have often sold a holding and bought back in again at a future date.”