The fear of loss is a powerful emotion for investors and can lead to years of forfeiture of investment gains.
Human evolution makes that fear happen. Our brains are capable of detecting risks and helping early humans and their forbears stay alive if they had to choose between survival or food.
Ancient threat-detection and loss-prevention mechanisms can do us a disservice in the modern era.
Dan Egan is vice president of behavioral finance and investing at Betterment. We were able to deal with natural threats.
Loss aversion bias plays out for investors.
The pain of an investment loss is twice as bad as the pleasure of an equivalent gain. Financial loss is avoided by investors.
The bias was shown using a coin-toss thought experiment.
If it's tails, you lose $10. How much do you need to make this gamble acceptable to you? Kahneman said that people want more than $20 before they're accepted.
Loss aversion can be expressed in surprising ways for society as a whole.
One group of teachers in Chicago Heights, Illinois, were told they would receive a year-end bonus based on student achievement. If students missed performance targets, part of the lump-sum payment would beclawed back.
There wasn't an impact noted in the "gain" group that offered a bonus incentive.
Automatic increases in a worker's 401(k) savings rates from year to year help combat bias. When a worker starts saving in a 401(k) they never experience a decrease in take- home pay because the savings are deducted from the beginning.
Inflation increases U.S. household spending by $433 a month.
Most investors have faced fear this year.
The S&P 500 is down more than 15% this year. The U.S. bonds have lost money in the last two years. It would be the first time in almost 50 years that both finished in the red.
Loss-aversion bias can cause investors to make bad decisions.
It could lead a long-term investor to be too conservative for fear of losing money. An investor with decades until retirement may be overweight bonds and cash relative to stocks, which are generally riskier and more volatile than the other "safer" asset classes. Retirees need stock exposure to beat inflation over the long term.
It can cause would-be investors to avoid investing in the first place. The risk is increased when markets suffer large losses. New investors are hesitant to put money into the market because they want to make sure it's safe.
A run-up in stocks is riskier than a pull back because the pain may be in the past and there is more upside to be had.
We didn’t evolve to live in financial markets.
In order to avoid further losses, human psychology can push investors to sell during a downturn in the stock market. They may miss out on gains when the stocks they sold come back to life.
In the year in which there were two big market corrections, the average investor lost more than the S&P 500.
An investor who kept their initial $10,000 in U.S. stocks for 15 years would have made more money than someone who missed the best days of the market.
It's a major reason why investors don't do as well as they could in the market.
Data shows that some people sought out safe havens in their 401(k) plans.
Stable value and money market funds captured 81% and 16% of net 401(k) plan savings in October, according to Alight Solutions. 401(k) investors withdrew money from stock mutual funds.
According to Alight, 18 of 21 days in October favored the fixed income category. Fixed income was favored by investors more than any other type of investment during the year.
Financial advisors say that the best choice for investors is to stay put for a long time.
Philip Chao is the principal and chief investment officer at Experiential Wealth in Cabin John, Maryland.
You will get in an accident if you panic.
He said that most investors are reactionary and acting in a well-intentioned way. They tend to be all over the place when markets go down.
The timing of the market is related to selling out of stocks while there is blood in the streets. When to sell out and when to buy back in is what investors need to know.
It is almost impossible for a professional investor to do that.
If you make the wrong bet, you will probably buy when stocks are expensive and sell when they are cheap. If you overreact to protecting your money, you may end up sacrificing your future earnings and ending up with a smaller nest egg.
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