Avoiding Loss Aversion in Investing
We naturally don’t enjoy losing – whether it’s just a through a friendly sports game or an intense competition, we’ve all felt that sting before. What you may not realize is that we naturally despise losing so much that we notice it far more than a gain. In fact, multiple studies show that losses are felt approximately two to two and a half more times than victories.
Our resulting behavior is known as loss aversion – a psychological phenomenon where humans will tend to go far greater lengths to avoid losses than they will to win. On an evolutionary basis, this often proves fruitful, but when it comes to your wealth, avoiding loss aversion in investing is often a key to long-term success.
Why is avoiding loss aversion in investing important?
Due to this bias, you most likely will notice short-term losses in your investments far more than gains. When it comes to the stock market, for instance, you will probably pay more attention when the market is down and be inclined to take action to avoid further losses.
This inclination can prove dangerous when you’re tempted to take action after feeling a loss. Look no further than the recent subprime mortgage crisis – where many investors strongly felt the stock market crash and rashly sold all their investments. Overall, they ended up selling their investments at a severe loss, while also missing the eventual recovery (and new highs) of the stock market.
How can you avoid this?
Avoiding loss aversion in investing entails looking at your investments through a rational, long-term perspective. Although it may go against your basic instincts, keeping an eye your long-term gains over time can abolish the need to take action to avoid a brief loss.
Realize that in the end, loss aversion in investing often does the exact opposite of its intent. By “avoiding” a brief loss, investors are often setting themselves up for a much larger loss over time.
Want to learn more about avoiding loss aversion in investing?
At LexION Capital, we help our clients keep their eyes on the prize by crafting unique investment solutions that focus on achieving their long-term goals and needs. Our fiduciary advisors have decades of experience and make rational investment decisions firmly grounded in academic research. If you would like to learn more about our perspective on investing and to see if our services may be right for you, don’t hesitate to start a conversation with us today.