Why falling in love can be very costly

Over the last five weeks we've been looking at Derrick Niederman's different investor types. I firmly believe that using Niederman's work to better understand your personal strengths and weaknesses is the biggest step you can take to becoming a better investor.

And now we're down to the last two investor types. This week we're tackling the sentimentalist.

"I'm not one of those!" you might think. But in fact we're more prone to sentimentalism than we care to admit. I mean does this sound anything like you?:

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You are fiercely loyal.

You hate change. A new colleague at work, or perhaps a new housing development in your area will cause consternation.

You've had the same hairstyle for the last twenty years.

You're a bit of a hoarder. You're probably still humping your old vinyl LPs from one place to another in the loft. And all those old company reports cluttering up the office!

You don't need the latest gadgets. Why bother?

If an investment is in a downswing, then it's only a matter of time before it comes back up again.

I know I recognise some of those traits. But don't despair. It's not all bad.

A sentimentalist is passionate about a stock or sector. And that's great news. After all, we want passion from management and employees so why not shareholders?

And this un-erring passion for a stock means the sentimentalist isn't easily shaken out of his position by any short-term turbulence.

Many would argue that legendary investor Warren Buffett is a sentimentalist. He just loves stocks like McDonald's, Gillette and Coca Cola. Of course it's not just nostalgia that draws him in, but an incredibly strong brand.

The point is sentimentalism needn't be a bad thing. Just so long as you steer clear of the pitfalls. Here are three of the worst.

Falling in love can be costly

The sentimentalist has a retentive personality. He sees his possessions as an extension of himself and therefore he hates to chuck them out. And that's true of his stocks too.

And there's always an excuse for it. Whether it's having to pay capital gains tax or steep trading commissions he'll always find an excuse to hold on too long.

If you suffer from under-trading, then it's especially important to hold your stocks in a tax efficient wrapper like an ISA. You may get more than just the tax saving. If it stops clouding your judgement when it comes to sales-time, then that's another great advantage.

It's dangerous to live in the past

Warren Buffett talks about a brand as an economic moat' Coca Cola or McDonald's are just timeless and they're brands that aren't easily replicated. But the sentimentalist takes the idea too far. He's blinkered

Unlike our friend the visionary, the sentimentalist has a nasty habit of living in the past. He just doesn't get progress.

To my mind, the most important change over the last couple of decades has undoubtedly been the rise and rise of the internet. But many investors missed the big idea.

"Oh people will always buy clothes in-store. They like to feel the texture of the fabric" they say. "Aargh books you're always going to want to flick through it before you commit."

And they'll make the same argument why CD and DVD sales will always have a place on the high street. But CDs and DVDs may not even exist in a few years time!

The point is the sentimentalist doesn't see change coming.

HMV management were convinced of the longevity of their business. But they were sentimentalists. As music stores were shutting down left, right and centre, they consolidated their position. They were left as the last men standing. As if that wasn't bad enough, they then went and bought Waterstones the biggest chain of bookstores.

Wow these boys didn't have a clue what was coming! The move toward digital content and internet sales has skewered the business. And any sentimental types that went along for the ride are surely regretting their blinkeredness now.

It's never as good the second time around

You know the feeling. You had a terrific long weekend at that little B&B down in Cornwall, so you figure you'll book it up again.

But the next time you go the pieces of the jigsaw just don't seem to fit into place. The fish is off, the weather is lousy and the new proprietor is a cantankerous old git.

Niederman blames it on the halo effect of former glories. We deeply want happy experiences to repeat themselves. Especially when it comes to making money!

Sentimental types fall for it every time. They see a chart of a stock that's turned down and are convinced it's just a matter of time before it turns up again.

That sounds like the contrarian we met last week doesn't it? Alas no. A contrarian does his homework and believes there are very strong reasons for a business turnaround. He thinks the market has overreacted on the downside.

A sentimentalist, on the other hand, has no evidence for his assumption that the stock will recover. He just says "Oh sales will take off again it's just a matter of time, these things are cyclical"

And worse

"I made so much money the last time the stock ran-up, and now I've got a chance to do it all over again!"

This is deeply flawed thinking. And it's lazy investing.

I'm a firm believer in investment cycles. But to put blind faith in the fact that a stock will come back' without looking at the bigger picture is bound to set you up for a fall.

How to avoid the sentimental trap

But here's what sentimental types usually miss: when it comes to investments, the real attachment is not with the company so much as the money made from it.

Did you really fall in love with BP or was it just that you profited handsomely as it ran-up to six or seven quid?

I suspect it's the latter. The key is to disassociate the pleasure of owning a stock from the pleasure of making money from it.

Similarly, maybe the joy of that weekend break came from the excitement of doing something different. The fact that on the day, everything fell into place for a wonderful experience. Maybe it had nothing to do with the place per se. As an investor, you have to forget the past. You need to constantly keep looking for new opportunities.

Or you could just let me look after that side of things for you. As it happens I have a couple of exciting opportunities that I'm working on at the moment. And I hope to tell you all about them in the Right Side very soon.

This article is taken from the free investment email The Right side. Sign up to The Right Side here.

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