Course 407: Psychology and Investing
Loss Aversion
In this course
1 Introduction
2 Overconfidence
3 Selective Memory
4 Self-Handicapping
5 Loss Aversion
6 Sunk Costs
7 Anchoring
8 Confirmation Bias
9 Mental Accounting
10 Framing Effect
11 Herding
12 The Bottom Line

It's no secret, for example, that many investors will focus obsessively on one investment that's losing money, even if the rest of their portfolio is in the black. This behavior is called loss aversion.

Investors have been shown to be more likely to sell winning stocks in an effort to "take some profits," while at the same time not wanting to accept defeat in the case of the losers. Philip Fisher wrote in his excellent book Common Stocks and Uncommon Profits that, "More money has probably been lost by investors holding a stock they really did not want until they could 'at least come out even' than from any other single reason."

Regret also comes into play with loss aversion. It may lead us to be unable to distinguish between a bad decision and a bad outcome. We regret a bad outcome, such as a stretch of weak performance from a given stock, even if we chose the investment for all the right reasons. In this case, regret can lead us to make a bad sell decision, such as selling a solid company at a bottom instead of buying more.

It also doesn't help that we tend to feel the pain of a loss more strongly than we do the pleasure of a gain. It's this unwillingness to accept the pain early that might cause us to "ride losers too long" in the vain hope that they'll turn around and won't make us face the consequences of our decisions.

Next: Sunk Costs >>


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