Loss aversion is a bias whereby you feel the pain of losses more strongly than the pleasure of gains. This can impact how you invest for your retirement.
Nobel Prize-winning economist Daniel Kahneman’s book Thinking, Fast and Slow explores how the brain processes decisions and the biases that often shape them. One of the most impactful biases he discusses is loss aversion, a concept that has significant implications for investors.
Understanding loss aversion
Loss aversion refers to the psychological tendency to feel the pain of losses twice as strongly as the pleasure of equivalent gains. Imagine losing $100 at a casino; it likely feels far worse than the satisfaction of winning the same amount. This bias has been well-documented in behavioural economics and can influence investment decisions in ways that may not align with long-term financial success.
The stock market and loss aversion
Historically, the stock market has been positive three out of every four years (or 75% of the time). Even on a daily basis, the market is up about 55% of the time, just slightly better than a coin flip. However, because of loss aversion, many investors don’t perceive it this way.
If roughly half of all trading days result in losses, and losses feel twice as painful as gains, it can make investing seem like a losing battle. To the average investor, the market might feel like it’s down two-thirds of the time, even though the data tells a much more optimistic story.
How to combat loss aversion
So how can investors overcome this psychological challenge? Kahneman offers a simple but powerful strategy: stop checking investments so frequently. He explains:
“The combination of loss aversion and narrow framing is a costly curse… Individual investors can avoid that curse… by reducing the frequency with which they check how well their investments are doing. Closely following daily fluctuations is a losing proposition, because the pain of the frequent small losses exceeds the pleasure of the equally frequent small gains. Once a quarter is enough.”
In other words, constantly monitoring investments amplifies stress and makes loss aversion even more pronounced. Checking too often can lead to emotional decision-making, which often results in buying high and selling low, one of the biggest mistakes investors make.
Real-life experience
Financial advisors consistently see this pattern play out. Clients who check their investments frequently tend to experience more anxiety and are more likely to make impulsive changes. On the other hand, those who review their portfolios less often tend to have a better overall experience. They focus less on short-term fluctuations and more on long-term growth.
While it may not be easy to fight against ingrained biases, understanding loss aversion is the first step. By limiting exposure to daily market movements, investors can improve their financial well-being and perhaps even enjoy the journey a little more.
This article was written by Andrew Rosen from Forbes and was legally licensed through the DiveMarketplace by Industry Dive. Please direct all licensing questions to legal@industrydive.com.
