Learn the trading mistake that I made, corrected, and ended up increasing returns by 32%

A few months ago, I bought some shares of Apple stock. Being new to investing and not wanted to risk too much, I only bough a couple of shares at an initial price of $461 for a share.

During this time period, Apple had not even announced the release of the iPhone 5s and 5c, so the shares were still trading at a pretty low price. Following the announcement of their next generation of phones, shares shot up to $500 a share, and I was pretty happy with myself. I made a good stock pick which went up $40 and was looking to climb higher.

Not long after, shares began to drop again. Because sales of the new iPhone in China didn’t meet expectations, the share price dropped. They dropped to as low as $550 dollars, and I started to get uncomfortable in my Apple stock position. When shares came back up, I sold my stock at $465 for a meager gain of $4 per share.

Two weeks later, I realized I made a big mistake, and ended up buying a couple more shares of Apple’s stock at $478. I’m still holding those shares at the moment which are currently priced at $633. What mistakes did I make that I want to pass on to you?

1. “Invest in great companies at good prices”

The situation with Apple was a perfect representation of Warren Buffet’s quote above. Apple shares were trading at a very low price. The price-to-earnings ratio was only around 12. Compare that with the S&P 500 which averages around 15 and is currently at 19.2 as of May 31, 2014. Apple was trading at a bargain at the time, and is still at a very cheap price. Considering the brand and the great products Apple puts out, you would expect their PE ratio to be much higher. This is a sign of a stock that you want to keep in your portfolio and hold on to for a while.

2. Don’t be affected by daily fluctuations, meaningless news surrounding the company, and investor expectations and fears which make stock extremely volatile in the short term.

I sold my Apple stock because I was reading too much news about the stock and let other people’s opinions about the stock price influence my investing decision. Instead of trusting my research and my own judgment, I let other’s judgment scare me into selling my stock. I knew the stock was selling at a bargain, but I was more influence by what was happening on a short time frame. Apple’s stock jumped up $40 and subsequently dropped $50. I panicked and sold the stock for a meager gain because I didn’t want to lose money. Trust your judgment and research.

3. Have a long-term horizon when investing in great companies.

You are not going to make a bunch of money quick by investing in great companies, but you can get returns which can potentially beat the market. People who make money on short-term investments are more so lucky than anything else. Use a long-term approach, and invest in great companies which are undervalued. Chances are, the share price will bounce back up and you will make some nice gains as a result. Just look at my position in Apple’s stocks. They have jumped up 32% since I rebought shares, and I couldn’t be happier.

Conclusion

Learn from your mistakes and don’t let the market decide what the value of your investment is. If you own a home, do you call your broker every day to see what the value of your home is? If someone offered you a low-ball price on your home based on the price your neighbors were selling their home, would you take it? Probably not, because we don’t live in homes with a short-term outlook. Why should you with your stock positions?

 

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What is anchoring and how can it make you spend money?

Anchoring is a psychological heuristic that influences your ability to assess probability and make decisions. Anchoring is the common human tendency to rely on the first piece of information which is available to them, known as the anchor.

In more general terms, anchoring is the idea that we start with some information, a specific number for instance, and then work our way from there to make a decision.anchoring makes you spend money

Case study

Drazen Prelec and Dan Ariely conducted an experiment at MIT in 2006 where they had students bid on various items, such as a bottle of wine, a cordless trackball, and a textbook.

They had student write down the last two digits of their social security number, and had them pretend that this was the original price of the item. They then held an “auction” where they asked each student how much they would pay for each item.

For example, if the last two digits of their social security were “82”, the student would write down 82 on the top of their page, and then write $82 next to every item listed on the sheet of paper in front of them. Once this was done, the professors would describe each product, and the students would write down how much they bid on each item.

Remarkably, the students with the highest social security numbers (from 80-99) bid the highest amounts and those with the lowest (1-20) bid the least amount. As a matter of fact, those who had a social security number in the upper 20 percent bid 216 to 346 percent higher than those in the lowest 20 percent!

The crazy thing about this study is that the student did not believe writing down their social security number next to each individual item would affect their bidding. However, that number next to each item subconsciously made the students spend more (or less) than their peers depending on how high or low their social security number was.

What does this study prove?

We are affected by the first number that we see when it comes to making a decision. Although you can deny it all you want, anchoring is a common way that people make decisions, especially when it comes to making a purchase. The study above, along with many others, have shown that people use the initial number as a starting point and then work their way up or down from there.

Businesses use anchoring to make you buy more

How often have you bought a product because it was 50 percent off? Or how often have you bought something from the grocery store just because it was buy one get one free, even though you didn’t really need it? Did you ever stop to wonder why you bought that product?

Anchoring is the reason we buy products that are on sale and listed so cheaply. We have an initial number in our head, and we work our way from there to make decisions. If you don’t have a number already in your head, manufactures will certainly remind you what retail price is.

How can you avoid anchoring?

Unfortunately, studies have shown that it is almost impossible for us to avoid anchoring. They show that the moment we are presented with an anchor, our minds are contaminated and have a tendency to always go back to that number.

Take gas prices for example. Personally, my anchor for gas prices is around $2.30, which is the price gas was when I first started driving a car. It was the first number that I was familiar with when I had to first pay gas, and every time the price of gas goes up I think back to the days when it was only $2.30 a gallon.

If I can’t avoid anchoring, what can I do?

Anchoring is hard to avoid. The fact is, we do it on a daily basis. One way you can avoid anchoring through your purchases is the ask yourself: do I need this? Sure, it’s great to see something that is 50% off, but does that change the fact whether or not you really need that item? Probably not.

Ultimately, the best thing you can do is be more aware of anchoring and seeing how it effects you in your everyday life as a consumer. By understanding that you make irrational decisions due to anchoring, you will be more likely to make wiser decisions in the future.

What purchases have you made due to the anchoring effect? 

Changing Plans and Shifting Gears

I want to make a quick blog post updating my progress on my guide to personal finance. I have decided that I will split up the original guide into multiple parts which will relate on various personal finance topics, starting with debt. In the next month or so I will be revealing the “Comprehensive Guide to Controlling and Conquering Your Debt” which will be completely free to anyone who visits my blog.

The guide will cover many topics of debt which I have posted on my blog over the past month or so, along with a few new topics which I have not yet discussed. This guide will also be available as an eBook in pdf format if you subscribe to my blog. All you need to sign up is your email address to get started!

Why am I doing this?

There are thousands of personal finance blogs online which are all great resources of information. The goal of creating these guides is to provide one comprehensive place for you to access this information in an organized manner. Each guide will be like a mini book which will provide a wealth of information and actionable tips for you to get started on your journey to financial freedom.

How do I get started?

Just fill out your email information below and hit subscribe. Once the guide comes out you will be the first to know and I will send you the eBook straight to your inbox without any effort on your part.

Businesses know how to make you buy a product. Don’t become a victim of their mind tricks.

What an amazing deal! I can’t believe I’m getting such a steal! 

When buying a product on credit, it’s not hard to fall victim to believing you got a great deal. Big companies know how consumers think and they know how to get a product into their hands as quickly as possible. Millions of dollars are spent advertising and researching consumer behavior.

One technique companies use to peddle their product onto consumers is to make them believe they are getting an amazing deal. I’m sure you’ve seen infomercials which tout that you can buy a product with “6 easy payments of $99 a month, no money down!” Would you still but the product if they told you it was “$600 dollars plus interest at a ridiculously high interest rate!” I don’t think so.

This same thing goes for cars. In the last article I discussed the negatives of taking out car loans. Once again, companies with throw out phrases like “only $299 a month for 60 months.” For them, it’s all about framing and making your gigantic purchase seem not so gigantic. When you spend a little amount over a long period of time you are dying a very slow but painful financial death of a thousand cuts. You become a servant to the lender and lose any chance at financial freedom.

The little things add up on both sides of the coin

You know how saving small amounts over time can add up? Well spending small amounts over time can have that same effect, except you suffer instead of benefiting. Don’t get fooled into thinking you aren’t paying a lot. Don’t look at purchases as payments in monthly installments. Take a step back and realize what the total cost of your purchase is, and then decide if it is really worth it to you.

We are all victims of the instant gratification bug

Instant gratification. We are all guilty of it. How could we not be. We live in the of the fastest generations ever. I was on Amazon the other day looking for books to read and stumbled across one that was on my short list of books to read. I went to the page for the book and in less than 10 seconds and the click of a single button, that book was delivered to my Kindle. I even commented to my friend how scary it was that I just bought something with the single click of a button.

With how quickly it is to buy things now, it is easy to get tripped up and knocked off the path to financial independence. In a matter of seconds you can spend hundreds, heck, even thousands of dollars. Back in the olden times you actually had to get in your car, drive to a store, find the item you wanted before you could even purchase it. You had time to think about the purchase you were about to make before you made it. By the time you got to the store you may have even reconsidered making the purchase altogether.

Once again, companies are behind making it easier for consumers to buy products. The faster you can buy a product, the less time you have to think about whether or not you truly needed it. It is their job to figure out how to get a product into your hands as fast as possible. Look around you. It’s everywhere. Fast food, Wal-Mart on every corner, one click purchases.

Considerations you should make before a major purchase

1)      Do I really need this product?I advise you, before you buy a product, take exactly three minutes before you click buy and consider the following:

2)      Will I still be satisfied with this product in six months?

3)      Does this product help improve my life?

4)      Is this not an impulse purchase?

5)      Can I afford this product without going into debt?

6)      Finally, Do I have a good reason for this purchase?

psychology of debt

The more “Yes” answers you have, the more likely it is that your purchase is a good one. It can be a dangerous trap when you combine instant gratification with credit cards. Not only are you mindlessly buying something, you are buying it with debt which can take months or years to pay off. This is precisely why I advise you take at least three minutes to really think about what you are about to do. Don’t set yourself back two years for a purchase you made in ten seconds.

Summary

  • Companies know how consumers think, and will make a large purchase appear smaller by giving you the cost per month instead of the total cost of a product.
  • Just like saving a little bit adds up over time, spending a little bit in monthly installments will add up over time. Understand the actual cost of your purchase.
  • Companies know consumers seek instant gratification and have responded by making products quicker and easier to buy.
  • Take into consideration the six questions I listed above before you make a major purchase. Don’t let a split second decision set you back years.

Photo Credit/Flickr User Paul Inkles