Imagine you face the following pair of concurrent decisions. First, examine both sets of choices, then choose the option you prefer from each.
1. Choose A or B.
A. A sure gain of $2400
B. a 25% chance to gain $10,000 and a 75% chance to gain nothing.
2. Choose C or D.
C. A sure loss of $7500.
D. A 75% chance to lose $10,000 and a 25% chance to lose nothing.
The way that you respond to this question tells a lot about your approach to investing. Choosing A in the first decision would be the risk-adverse choice. Most people find a sure $2400 difficult to pass up. Although $10,000 is a lot more than $2400, the odds of collecting it are only one if four. Hence, the expected value of B is $2500; considerably less than $10,000. In fact, $2500 is just a bit more than the guaranteed $2400 offered in A.
The second decision is basically the same as the first. Did you respond the same way? In studies, 90% choose D in this case. They want the chance to breakeven, and lose nothing.
You see, the two decisions represent a “package,” but most people do not recognize it. They separate the choices into “mental accounts.” The correct option here is to stick to one style of investing; whether it’s taking risk or avoiding it. You should not be thinking one way with profits and the opposite way with losses. This is exactly why a majority of unsuccessful investors cut their winners short, and chase weak stocks to zero before bailing out and realizing a loss.
If this sounds like you, you need the Gorilla!