Some investors’ fear of losing money compels them to completely avoid the stock market and other volatile investments. This phenomenon is often called “loss aversion.”
People suffering from loss aversion will sometimes wait until they see the market has gone up a lot, and then they invest. They forget about history and just believe that the economy will continue strengthening. They often buy into the market at a high, and then when it tumbles, as it inevitably does, they sell out. As any financial professional can tell you, selling when the market is low and buying after its peak is a formula for failure.
Investors who try to time the market may lose money. If they resist the urge to sell when the market falls and continue to hold through the market’s recovery, they may have kept – or increased – their portfolios. As Nobel Prize winner Professor Daniel Kahneman says, “The main implication for loss aversion in investing is that you have to think about what you could sustain without changing your mind or without changing course.” In other words, if you want to invest in the stock market, which could turn out to be a wise choice, you must have the stamina to deal with the volatility. Naturally, past performance is no guarantee of future returns.
Fear of risk
Total avoidance of risk may mean limited returns, or even worse, losing due to inflation. For example, if you could buy a basket of groceries today for $100, it might cost you $105 next year if inflation is 5%. If your investments don’t grow accordingly, you will have lost buying power.
Regardless of how you characterize yourself as an investor, if you understand the psychological barriers that cause people to make poor decisions, you should be able to plan logically.
To learn more about loss aversion and why worrying about the stock market may not help you, read profile-financial.com/worry-stocks
For more about loss aversion, read this.
Douglas Goldstein, CFP®, is the Director of Profile Investment Service, Ltd., which specializes in helping people who live in Israel with their US dollar assets and American investment and retirement accounts. He helps olim meet their financial goals through asset allocation, financial planning, and using money managers.
Published April 13, 2015. Updated January 2020