While many retail investor favorites like NVIDIA Corp. (NVDA), Apple Inc. (AAPL), and Tesla, Inc. (TSLA) have delivered impressive returns over time, emotional attachments to specific stocks are often part of powerful cognitive biases that could be silently undermining your portfolio.
Understanding why you can’t let go of these market darlings, especially during serious volatility, could be key to obtaining better returns over the long haul.
Key Takeaways
- Emotional attachment to stocks often results from cognitive biases.
- Recognizing when these exist with your favorite stocks can help you make better decisions, potentially improving returns while reducing the risk of portfolio concentration.
The Psychology Behind Stock Favorites
A person’s attachment to stocks like Amazon.com Inc. (AMZN) and Tesla might run deeper than they realize. Neil R. Waxman, a financial advisor and managing director of Capital Advisors in Shaker Heights, Ohio, is a major proponent of understanding the behavioral biases behind our investment decisions.
“The two most common behavioral biases are confirmation and recency bias,” Waxman said. These biases are likely related to emotionally holding on to certain favorite stocks.
Waxman said confirmation bias is when an investor is predisposed “toward consuming information which only confirms their own bias, creating a circuitous vacuum of information, which continues to reinforce and confirm their beliefs in an escalating manner.” This behavior doesn’t make you unusual, he said. “It’s natural for this to happen and hard to resist.”
Recency bias is basing decisions on what has occurred most recently and projecting it indefinitely into the future, Waxman said.
Tip
The clearest red flag that you own too much of a popular stock is portfolio concentration. If shares in a single company make up more than 10% of your investments, you may be overexposed.
Example: Tesla
Despite issues related to the company’s China exposure, vulnerabilities to tariffs, and an evolving and competitive EV landscape, retail investors poured billions into Tesla shares even after news of plummeting international sales broke—while institutional investors headed for the exits.
Interactive Brokers’ chief strategist Steve Sosnick told Investopedia he’s taken to calling Tesla a “faith-based stock” since investor loyalty “is based less on corporate fundamentals than futurism—robotaxis, etc.,” which means overlooking headwinds the company is facing. “If you’ve already decided that the stock is all about the future, you can overlook some pesky details about the present.”
Retail investors’ faith in Tesla’s stock could illustrate psychological biases. For example, confirmation bias might lead Tesla enthusiasts to selectively consume positive information by focusing on Musk’s promises of future innovations while dismissing current sales declines. Recency bias could cause investors to extrapolate Tesla’s historical market-beating returns indefinitely forward, despite major changes in the EV and related markets.
Warning Signs of an Emotional Stock Connection
Of course, as with almost any other example we could use, there might be a strong investment case for Tesla that has nothing to do with such biases. “Tesla’s long-term growth prospects still remain strong, driven by its thriving energy generation and storage segment, expansive supercharger network, and AI advancements,” John Blank, chief equity strategist at Zacks Investment Research, told Investopedia.
The point is to ensure that your assessment of a stock is based on fundamentals. How can you tell? If you find yourself checking, say, Nvidia’s stock price multiple times daily or getting offended by criticism of Apple’s latest product, these are classic signs that you have clouded your investment case with emotions.
Another warning sign is your reluctance to sell even when valuations reach extreme levels or the fundamentals change. For any stock you own, you should be able to list specific criteria for when you would sell it.
The Bottom Line
With stocks, the line between rational conviction and bias is often razor-thin. You can combat biases by using automatic rebalancing to maintain target allocations, so no stock becomes too big in your portfolio, and by deliberately seeking contrary opinions before and after buying a company’s securities.
