Is Loss Aversion Holding You Back On Your Investments?
All of us have things that we really value, whether it be a goal, a dream, a possession. Whatever it may be, the thought of giving it up, or being unable to attain that valuable possession or dream is devastating. Now imagine you’re told that if you lay that object on the line in a bet, you have a good shot at doubling its value, but there’s also a possibility you’ll lose it. How low would the chance of loss have to be before you’d be willing to take the risk? Maybe 10%? Less than that? The answer may lie in a behavioral economic theory called “loss aversion.”
Are You Willing To Take A Risk On Your Retirement? Or Is Loss Aversion Too Great To Put Everything On The Line.
Now imagine it’s your dream of retirement and the money required to reach that dream is on the line. How low does the risk have to be then for you to be willing to take it? Muddying the waters further: how does your thinking change if you’ve just lost that favored possession? No one likes to experience loss; as humans, we often find it painful. So painful, that the prospect of experiencing the pain of loss can paralyze us from taking another risk, even when it’s potentially small or when the rewards of taking the risk are potentially great. In a volatile and uncertain market and economic environment like we’ve been in since the 2008-2009 financial market crisis, there’s a strong chance that any given investor has recently experienced some type of loss.
No Pain No Gain, Are You Willing To Take A Risk For Something Better?
Dan Ariely, Professor of Psychology and Behavioral Economics at Duke University said, “People hate losing much more than they enjoy winning. How happy are investors when they make 3% on their investments and how miserable are they when they lose 3%? There is a tremendous asymmetry.”It’s certainly understandable for investors to make financial decisions based on a desire to avoid the pain of loss, but that may not always be productive for portfolios in the long term. For example, the low-risk, low- yield investments that investors are turning to in their “flight to safety” are actually not all that safe. If your “safe investment” isn’t offering a rate of return that can stand up against inflation then you can chalk it up with all the other losses. Then it really isn’t so safe after all. Because realistically, a loss is a loss, no matter what the reason.
If you are finding yourself relating to talk on “loss aversion” than perhaps it is time you speak to a financial advisor who can help you lay out your feelings on risk and loss, to figure out where you are on the risk ratio spectrum. Once you are sure on where you stand personally you can make a better financial decision that can propel you towards meeting your future financial goals. Click Here for more information.