How to prevent anchoring from sinking your portfolio
One tricky thing with investing is that things are always changing. An indestructible monopoly one day (can you believe that Microsoft (MSFT) was almost broken up by the government over the bundling of Internet Explorer with Windows?) can find itself suddenly behind the times and struggling to catch up a mere decade later. Similarly, sometimes all it takes is one or two amazing products to turn a tiny and irrelevant company like Apple (AAPL) into the largest publicly traded company in the world over the same time period. Check out the turnover among largest companies just in the last 20 years or so below:
Some companies like Exxon (XOM) and Microsoft (MSFT) are still going strong or have even rebounded, but others like General Electric (GE) have had a much worse time. It’s even more amazing if you go back a few decades more and see companies like Sears, Eastman Kodak, and Polaroid on the list.
While this constant change is tricky and challenging, I also find it incredibly exciting as well. Yes, dominance in the market can be fleeting, but that means there are smaller, fast growing disruptors ready to replace the old dinosaurs. My biggest winners so far haven’t been from huge companies that seem to have monopoly on some huge industry. My biggest winners have been the companies pushing forward creative destruction and disrupting those industries or even creating entirely new ones. Everybody thought Walmart (WMT) had an iron grip on retail in the United States until Amazon (AMZN) came along with eCommerce operation with an obsession on customer satisfaction. Nobody could compete with Blockbuster Video until Netflix (NFLX) put them out of business.
This constant churning and disruption and the speed at which it happens has some important implications for investing for me. For starters, it gives me an aversion to investing in those largest companies. Yes, I know Amazon (AMZN) is the largest holding in the Freedom Portfolio and I indirectly own Alibaba (BABA) as well, but that aversion has kept me out of companies like Apple (AAPL) and Facebook (FB) and Microsoft (MSFT) and played a role in me selling my position in Alphabet (GOOG). It’s also why I tend to avoid large established financial institutions. I’m always trying to be on the lookout for how companies can be disrupted both in terms of companies to avoid and for the challengers to potentially invest in.
The enemy to all of this is anchoring. What is “anchoring”? According to Wikipedia, anchoring “is a cognitive bias where an individual relies too heavily on an initial piece of information offered (considered to be the “anchor”) when making decisions”.
There are two main ways that I’ve noticed anchoring affecting my investing. One, is when I invest in a company with a thesis that gradually gets disproven over time without me noticing. Oftentimes this happens because there were a number of parts to the thesis that get knocked off one-by-one and not all at once. For example, maybe I invested in Alphabet because I saw a number of compelling opportunities for them:
- Entry into the Chinese market
- Smart home devices
- Increased hardware sales from the Pixelbook and Pixel phones
- Waymo and self-driving cars
- Cloud computing
- Youtube
Looks like a plethora of potential, right? Fast forward a few months later and how do things look?
- Project Dragonfly shut down after internal revolt by employees
- Google continues to lag behind Amazon in smart home devices
- The Pixelbook might be on its way out and Pixel phones haven’t exactly taken the world by storm
- Waymo doesn’t seem much closer to making money
- Google continues to lag in the increasingly competitive cloud computing race
- Ditto for Youtube
There was no single day where Google dropped a bunch of news that it was killing off Pixelbooks and Project Dragonfly. No company will brag about not being leader in a segment or lagging behind. As a result, it’s easy to just continue holding a position for months or even years without even second-guessing if the original thesis that caused you to buy it in the first place is still intact.
The other way that I’ve notice anchoring hurting my investing is when I get too irrationally hung up on some price per share. Oftentimes this takes the form of either the price I paid or maybe a recent high that the stock has pulled back from. Let’s take Activision Blizzard (ATVI) as an example. Just a year ago it got as high as $80 per share before crashing back down to $43 a share now. Let’s say I bought shares for $50 about two years ago and so am looking at a loss of $7 a share now. Maybe I no longer believe in the company (there has to be some reason the stock has dropped nearly 50%) but I’m a prideful person and just can’t stand taking a loss, so I decide to hang onto it until it gets back to $50 a share so I can break even. Or perhaps I bought for $40 a share and so am still up $3 a share now, but really can’t stop thinking about that $80 price point from just a few months ago and how I should’ve sold then and maybe if I hold on longer it will get back there.
Both of the above are examples of anchoring. There’s nothing magical or special about the $40 and $50 price points that I bought at, yet somehow I’m letting those arbitrary numbers influence if I still want to own the company. Owning a position in a company should be about whether or not you like the company’s prospects for the future. It shouldn’t be about what price you paid for shares or the most recent high.
So what is an investor to do? There’s a mental trick to combat anchoring that I use which I really love and I wish I could remember where I heard it so that I can give credit where its due. The trick is a simple one: Imagine that you wake up tomorrow and somebody has hacked your brokerage account and sold every single one of your positions and everything is now in cash. What would you do with that money?
Obviously this an imperfect and overly simplistic exercise since there would possibly be tax implications and fees associated with everything which might color your decisions. Still, just framing the situation this way can help illuminate any underlying biases that you may not realize that you had. If somebody forced you to sell a particular position, would you buy it back? If not, then that’s a pretty compelling reason to consider going ahead and selling it yourself.
I like to run this exercise a few times a year, and with the weather warming up and spring right around the corner, now seemed like as good a time as any. I did my best to take a dispassionate look at the Freedom Portfolio and decide, if Thanos snapped his fingers and every position was sold tomorrow, which positions I would buy back. Below are the decisions that I made, along with a brief explanation of why.
Sells
Axos Financial (AX) – I originally bought Axos financial back in 2013 when it was called “Bank of Internet”. The original idea was that, as an exclusively online bank that didn’t have to deal with the overhead of brick and mortar locations, they were better positioned to succeed. That lack of brick and mortar overhead allowed them to offer better interest rates on things savings accounts and CDs to gain market share while still allowing them to be more profitable than their legacy competitors.
It turned out to be a good investment, as the stock would go from around $10 when I purchased it all the way up to over $40 in the following 5 years. However, over the past 6 months or so the stock had pulled back some to around $30. While re-evaluating I realized that part of me was still anchoring to that $40 price and I even found myself thinking, “if only it could get back to $40 then I can sell it”. I realized then it was time to sell if the only thing keeping me from selling it now was a psychological attachment to a previous high.
nVidia (NVDA) – It’s been a rough few months for nVidia which saw it lose close to half of its value. While the immediate reasons for the drop should be relatively short term and something the company can recover from, I realized that I now have enough doubt about their edge in the competitive and constantly changing industry that they’re in that it felt like time to sell. My experience with chipmakers like nVidia is that it’s incredibly difficult to build any kind of sustainable competitive advantage or moat and that while you might have the best tech one year, there’s very little preventing an upstart competitor from overtaking you next year. I’m not saying that is going to happen with nVidia this year or next, but I would rather get out before it happens rather than after.
Bladex (BLX) – This one is simple. My original thesis for buying Bladex is that I wanted some exposure to the growing Latin American market and it felt like a good way to get it. Now? I can’t think of a single reason why I would own this instead of MercadoLibre (MELI), so it was an easy call to sell Bladex and use those funds to buy more MercadoLibre.
Baidu (BIDU) – There were three main points behind my original idea to buy Baidu:
- The threat of Google (GOOG) entering the Chinese market was being overblown
- They owned a large chunk of iQiyi (IQ), which I was pretty excited about
- They were making big investments in AI which should pay off in the future
Re-evaluating now, it seems like the concern over the threat of Google has passed, and I’ve become a little more skeptical of exactly how investing in AI is supposed to magically result in increased profit (whenever I think about it, I just imagine the Underpants Gnomes from South Park with a sign saying: “Invest in AI -> ? -> Profit”). I still really like iQiyi, but I’ve gradually been adding to my position in that company directly and there doesn’t seem to be a compelling reason to own the parent anymore.
Tencent (TCEHY) – A few months ago, I sold a part of my Tencent position to buy some Naspers, which is a South African company that owns almost a third of Tencent yet trades at a discount to Tencent’s valuation and offers some interesting diversification since they own some other companies as well (in fact, they just recently spun one of them off). Given that Naspers should provide about the same amount of exposure to Tencent in addition to some extra upside with their other businesses, I decided it made sense to just sell my Tencent position and transfer those funds into more Naspers.
Buys
Baozun (BZUN) – Speaking of the JIB, I continue to like the trio of companies and all three are up since I wrote the article. Baozun was the smallest position of the three and has performed the worst, so I decided to add a little more. There could be some short term turbulence with the trade war and a possible slow down in China, but I still like Baozun over the longer term.
CRISPR (CRSP) and Editas (EDIT) – I’ve long struggled with investing in biotech and pharmaceutical companies because I have a hard time understanding how much of an advantages certain companies have. I’m really tempted by the incredible promise of gene editing, though, and wanted to dip my toe in with Millennium Falcon positions in two of the leading companies in the field. I can’t remember who said it, but there’s a saying that basically says that the moment you buy a stock is when you least understand the underlying company. It may seem counter intuitive but I’ve found it to be true. Buying a financial stake in a company naturally incentivizes me to learn more about the company, so I look forward to just learning more about these companies in the coming months.
MercadoLibre (MELI) – As I mentioned last week in my MercadoLibre write-up, the more that I wrote about how much I liked the various avenues for growth that MercadoLibre has, the more amazed I was that I hadn’t added to my position since the original purchase. I finally decided to remedy that and added a fair amount, bringing the size of my position closer to my conviction in the company. As of today, it is now an Enterprise level position.
Teladoc (TDOC) – This is simply a situation where I started with a small position in a company that looked interesting and now I’m ready to commit a larger portion of my portfolio to it. Teladoc has hit some speed bumps recently, but I still believe the underlying trend towards telemedicine is intact and I’m ready to back up that belief with a larger position.
Naspers (NPSNY) – See Tencent above.
Spotify (SPOT) – Up until about a month ago I had very little interest in investing in Spotify. They just seemed like one more company trying to thrive in the difficult music streaming business. Not only did I not think they had any competitive advantage over their rivals, but I also wondered how they expected to be able to compete with huge tech giants like Apple and Amazon who also have music services.
All of that changed when they went out and bought Gimlet Media and Anchor amid a heavier push into podcasting. Suddenly I understood what their strategy is going forward and I find it to be an intriguing one. If Spotify can get exclusivity for some of the more popular podcasts, then that could be a powerful differentiator which could allow them to draw subscribers from other services or provide the ability to raise prices. The idea of paying for podcasts might sound silly to many, but I’ve come to realize that I probably spend more time listening to podcasts now than I do watching TV and if my favorite podcasts started charging a low monthly fee to listen, it would be something I would give some serious thought to. I have no idea if this new strategy will work out, but I’m intrigued enough to start a small position. A little off topic, but have I mentioned that my friends and I have started a podcast of our own?
So that’s what I do to try to prevent anchoring from sinking my portfolio. Do you have any similar tips and tricks? Thoughts on any of my buys or sells? Hit me up in the comments!