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loss aversion

The tendency to feel a loss much more strongly than a gain of the same size.

Loss aversion is the tendency to feel a loss more strongly than a gain of the same size. Losing $1,000 hurts more than finding $1,000 pleases. It's a normal human trait, studied in behavioral economics, not a sign of a weak character.

In investing it shows up in a few familiar ways: selling in a fall to make the pain stop, refusing to sell a losing pick because selling would "make the loss real", and keeping too much in cash because any fall feels unbearable. It gets stronger the more often you look. A portfolio checked daily shows a loss on far more days than one checked once a month, even when the long-term trend is up.

You can't switch loss aversion off, but you can plan around it: choose your mix of stocks and bonds by the worst fall you can actually sit through, check less often, automate contributions and write down in advance what you'll do when the market drops.

Example

Zapas's beta data split users by how often they opened the app. Of 50 users who checked daily, 25 sold during the drop (50%). Of 80 weekly checkers, 20 sold (25%). Of 70 monthly checkers, 7 sold (10%).

The fund and the fall were the same for everyone; what differed was how many red days each group saw. The beta wasn't a controlled test, so the data shows a pattern, not proof that checking causes selling. Synthetic data, for learning only.

Common mistakes

  • Checking the balance daily, which shows a loss on far more days.
  • Selling to stop the pain and then missing the recovery.
  • Holding a losing pick only to avoid admitting the loss.
  • Choosing a mix by its average return instead of the worst fall you can actually hold through.

Learn it in the course