What is loss aversion?
Loss aversion is our instinct to prioritize avoiding losses over pursuing gains. It manifests across many aspects of our lives, making it difficult for us to part with everything from delicate heirlooms to underperforming assets.
Loss aversion doesn’t just lead to missed opportunities, it also invites risk. The fear of loss – which can be twice as powerful as the satisfaction of gains – is so strong that bad decisions often result from attempts to avoid it.2
Loss aversion = lost potential?
Science backs up the power of loss aversion – and money is one of the things we’re most afraid of losing. One Stanford University study found that, while brain activity was heightened by both potential gains and losses, it was markedly stronger when participants faced the latter.
That fear can hold us back when investing. The unwillingness to part with something for less than you paid for it can keep you clinging to declining stocks – even at the expense of better performers.
When loss aversion factors into your financial decisions, you might:
- Assume unwise risks to try counteracting an existing loss
- Operate too fearfully and miss out on opportunities
- Cling to assets, even if they aren’t the best fit for your lifestyle or goals
- Hold on to investments that have lost value after you acquired them
- Put off conversations around disability, long-term care and legacy planning
How you can let go of loss aversion
- 1. Examine your holdings with fresh eyes. If you were starting from scratch, which would you still buy today?
- 2. Stress test your portfolio. This can give you the confidence to stick to a plan even when conditions get more volatile.
- 3. Move past loss. Instead of dwelling, focus on moving forward and progressing toward your goals.
- 4. Consider long-term market data. While markets may be volatile, temporary impacts don’t prevent consistent growth over time.
- 5. Look for help. In the case of your financial future, it helps to work with an objective third party – like an experienced financial advisor – who can offer perspective in addition to wealth planning and investment support.
While it’s natural to try to avoid loss, letting the fear of it dictate your financial decisions could result in missed opportunities and more. Counteracting loss aversion by cultivating a healthy relationship with risk could be the key to making gains in the long term.
