Disposition Effect |
| Credit: Medium |
Disposition Effect - Winners Get Out, Losers Stay Back
Meaning
The disposition effect is an anomaly discovered in Behavioural Finance. It relates to the tendency of investors to sell shares whose price has increased, while keeping assets that have dropped in value.
Investors are less willing to recognise losses (which they would be forced to do if they sold assets which had fallen in value), but are more willing to recognise gains. This is irrational behaviour, as the future performance of equity is unrelated to its purchase price.
Examples of Disposition Effect
• Investors wou Real Life Example ld like to sell the winners and hold onto the losers as they are entirely emotional driven. Basically, we feel better if we lock the gains and would not want to accept by selling the losers. We hold on to the losers at least until break. This will result in holding assets that are losing in value.
• People hold on to a piece of real estate which is not moving up in value or making losses, but, instead when they need money, they will sell another piece of real estate which has moved up in value.
Real Life Example
During the 2008-09 financial melt-down, Many people had invested in stocks and mutual funds. During the stock market collapse, many of such people's overall portfolio was in red but a few of the stocks and mutual funds were riding high.
Since they were fearful of losing the gains recorded on the high riding assets, they booked profits in them.
Whereas, For the ones in red, they decided to hold on until they break even. Few of them broke even, few were languishing in red and few went further down. Finally, many decided to clean up the portfolio, sold off everything, and rebuilt from scratch.
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