Do you have loss aversion?Lifestyle Newsletter
Nobody likes to lose. Human beings tend to be loss averse, and the pain of losing is twice as powerful as the joy of gaining.
What does this mean?
For example, the pain of losing $100 is often far greater than the joy gained in finding the same amount. As humans, we are wired to avoid pain or loss and will go to great lengths to avoid it. This can quickly lead to poor decisions. Fear of loss can lead to panic very quickly. We all know that when panic take over our thinking brain, the logical brain seems to go away, and logic is nowhere to be found. The interesting part is loss aversion can lead us to make poor decisions even before the panic sets in. Hence the word aversion. We can make small irrational decisions along the way if we think there is a possibility, we can lose something.
Why do I care?
Well, with the recent market volatility, loss aversion can cause us all to make decisions that can have a significant impact. The fear of loss can cause us to panic and want to cash out. We start thinking “what if the markets will keep going down and I lose everything". Now if you were looking individually at your investments and one was performing badly because of internal factors, that were unlikely to correct themselves, then it would be a good idea to cut your losses. To find out this information you would probably do your research and make a rational decision based on the facts. With today’s markets if your instinct is to cash out your investments without asking “why are my investments down?” or “is it likely that my investments will recover?” it could lead to you locking in your losses instead of them just being losses on paper.
Here is a great illustration of the "Manulife Monthly High Income fund" which shows the power of staying invested during down turns. The chart shows $100,000 invested in 1998 in the Fund which paid 5% annually every year till 2021. The total payout is $200,088.15 and the end balance is $238,875.63 after all payouts.