Money Behavioral Mistake #1 Loss Aversion

Loss Aversion. young horrified woman closing her mouth with hands over white background. Negative facial emotion. To be afraid to lose job
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Lessen your fear, because if you let it grow, it is you who will become small.

Amazonian Oral Tradition

Loss Aversion, related to Fear of Regret, explains why many investors will not sell anything at a loss.

Most of us hate to take losses. And people generally prefer to avoid losses than to achieve gains. The degree to which investors are averse to taking losses was illuminated in a 1979 study by Kahneman and Tversky, the Nobel Prize winners in Behavioral Economic Sciences. They found that a loss has about 2.5 times the impact of a gain of the same magnitude.

A loss has about 2.5 times the impact of a gain of the same magnitude.

Instead, if required to sell something, they sell those securities in which they have a profit. This is the opposite of the “cut your losses and let profits run” strategy recommended by many savvy investors.

The tendency to keep losing investments and sell profitable investments is called Disposition Effect.

the-only-thing-scarier-than-change-is-regret

Selling at a loss not only admits a mistake, but also ends any hope of at least getting back to break even, thus the Loss Aversion.

Financial professionals often hear from clients who state that rather than selling at a loss, they will sell when the stock gets back to the price at which they bought it. This “get-even-it-is” attitude can be very harmful to investment results because some stocks never will get back to the price at which an investor bought them or, even if the price does increase, it may take a very long time. In the meantime, better investments are passed by while waiting for the stock to rebound. In this case, what an investor does not do can be as harmful as what he or she does.

Rather than selling at a loss, they will sell when the stock gets back to the price at which they bought it.

Next. Read about Money Behavioral Mistake #2. Overconfidence (or Optimism Bias)

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