disposition effect

Syllable breakdown

Dictionary meaning

the tendency of investors to sell assets that have risen in value — realising gains — too quickly, while holding assets that have fallen in value — realising losses — too long, a pattern that is the reverse of what a rational tax-minimising strategy would dictate; the disposition effect was documented by Hersh Shefrin and Meir Statman and arises from the interaction of loss aversion and mental accounting: investors feel the pain of realising a loss more acutely than the pleasure of locking in a gain, so they sell winners quickly to bank the good feeling and hold losers to avoid the pain of acknowledging failure; the disposition effect systematically harms investor returns because winners that are sold early often continue to rise, while losers that are held tend to continue falling; the effect is consistent with prospect theory's prediction that people are risk-averse in the domain of gains — preferring the certain gain of selling — and risk-seeking in the domain of losses — preferring to hold and risk a larger loss rather than sell

Examples

• The disposition effect led the investor to sell his Amazon shares after a 30% gain while refusing to sell his energy stock that had fallen 40%.
• Shefrin and Statman's original study of brokerage accounts confirmed that investors sell winning stocks at higher rates than losing stocks throughout the year.