Do you experience “loss aversion”? It’s a phenomenon where loss is perceived as more severe than an equivalent gain, or when the drawbacks seem to outweigh the benefits. While we all experience loss aversion to some extent, this fear may be severe in some individuals that take drastic steps to avoid risk at all costs.
Although we would like to believe our thoughts and actions are always rational, we often make choices based on emotions rather than logic. Fear, especially, can strongly influence the decision-making process, particularly regarding our finances. When comparing the emotion associated with gaining money versus losing the same amount, most people will admit to feeling stronger emotions about the loss than the gain.
Loss Aversion and Financial Decision-Making
Loss aversion can often hinder someone from achieving their long-term financial goals, as it can cause investors to make irrational decisions. It can also lead investors to blame themselves when a particular investing strategy fails. A study from the National Bureau of Economic Research revealed that individuals experience a deeper sense of loss when it results from their own actions rather than a negative outcome out of their control. People with a higher sense of loss aversion tend to feel personally responsible for poor choices, which can stir fear of future investment decisions and a continuous cycle of anxiety.
Our level of loss aversion is often linked to how we are wired psychologically. It’s often associated with the “predictor area of the brain,” the part of the brain which helps us avoid perceived danger through prediction. For example, investors who have previously suffered significant stock market losses may prefer bonds over stocks, potentially delaying portfolio growth and missing out on potential market opportunities.
Overly Conservative Portfolios
Sometimes, loss aversion can lead investors to build overly conservative portfolios. Conservative investing strategies can benefit certain investors, especially if their portfolios include stocks of low-risk, well-established companies showing steady growth. However, an excessively conservative allocation to avoid all risk can limit returns, reduce purchasing power, and impede long-term portfolio growth.
Unfortunately, loss is part of life – and it’s also a part of investing. To cope with loss aversion and mitigate its effect, you may consider working with a trustworthy financial advisor. Having expert guidance and open lines of communication with your advisor may aid in alleviating some of the fears accompanying loss aversion. A financial advisor who has your best interest in mind and provides emotional support during market volatility can make a significant difference in reaching your financial goals.
At Moran Wealth Management®, we provide objective guidance and advice to help our clients make well-informed financial decisions. We understand how investment psychology and market philosophy work together, and we use that knowledge to deliver a fresh perspective to our clients. To set up a complimentary consultation with one of our financial advisors, call us at (239) 920-4440 or visit our website at moranwm.com.
Disclosure: This blog article contains general information that is not suitable for everyone and was prepared for informational purposes only. Nothing contained herein should be construed as investment advice. Moran Wealth Management, LLC (“MWM”) is a Registered Investment Adviser. The information contained herein is based upon certain assumptions, theories and principles that do not completely or accurately reflect any one client situation or a whole exposition of the topic. All opinions or views reflect the judgment of the authors as of the publication date are subject to change without notice. For additional information about MWM, including its services and fees, send for the firm’s disclosure brochure using the contact information contained herein or visit advisorinfo.sec.gov.