Investment Talk – Loss Aversion

Evidence suggests the pain of losing $100 is felt more than twice as much as the pleasure of gaining the same amount (Kahneman and Tversky, 1992).  This behavioural trait has led researchers to coin the term ‘loss aversion’.

Although somewhat irrational, an awareness of this behavioural inclination can help us control our emotions and prevent panic selling in times of backward market movement.  Mark my words there will be a point in time when your portfolio does experience a loss and it is important to remain steadfast and weather the storm.  Making reactive changes to your portfolio will only open the door to market timing issues where stocks are sold in a low market and purchased at peaks.  In fact is has been said that “more money has been lost trying to anticipate and protect from corrections than actually in them.” – Peter Lynch.

“Unless you can watch your stock holding decline by 50% without becoming panic stricken, you should not be in the stock market.” – Warren Buffett.  Although this example is somewhat harsh and plays to an extreme end of the spectrum, it highlights the volatile nature of share markets and the importance of sticking with a long term investment approach.  And as history has shown markets will typically reward the brave.