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Have you experienced loss aversion?

It is the propensity to be more sensitive to a loss than being happy about alternate gains. Its prominent not only in lifestyle activities but also in investing.

Have you ever paid for a service, say like a wine tasting or a city tour or even a movie experience, but are not enjoying it? What do you do, leave half way or stay on to recover the money already paid?

Researchers have found that most people are likely to stay on in a bad movie or continue on the tour bus despite not enjoying the experience, simply because they feel like doing so will mean they recover value for their money. 

There is a feeling that one loses out by leaving the activity mid-way. If you think about it, the money is already paid up; if the idea was to enjoy a show or a tour and that’s not happening, there is no point in sitting through the rest. Instead you can use that time to do something better. 

This kind of behaviour is part of a series of behaviours classified under what cognitive psychologists call loss aversion. It is the propensity to be more sensitive to a loss than being happy about alternate gains. Its prominent not only in lifestyle activities but also in investing. 

When it comes to investing, the loss aversion bias shows up in the inability of investors, particularly – retail investors, to sell where losses are high. Be it real estate, equity shares or mutual funds. You always try to wait it out, thinking that after more time elapses, chances of recovering losses increase. There is an inherent fear of taking home losses, hence, the evergreen hope that staying invested will help in reversing the loss. 

Loss aversion in investing

When it comes to investing, the loss aversion bias shows up in the inability of investors, particularly – retail investors, to sell where losses are high. Be it real estate, equity shares or mutual funds. You always try to wait it out, thinking that after more time elapses, chances of recovering losses increase. There is an inherent fear of taking home losses, hence, the evergreen hope that staying invested will help in reversing the loss. 

However, you must understand that by holding on to a bad investment, you are missing out on other good opportunities. If the investment is suffering an interim issue because of external factors and there is visibility of better growth, then one can remain invested. However, where you have made a bad investment, it's best to exit even at a loss. Take whatever you get from selling it and reinvest in a good quality investment that aligns with your real goals. 

The reverse can happen too. You may have bought an asset whose price shoots up soon after, fearing that it will move lower just as fast, you choose to sell. It is the fear of losing your gains and going into losses that makes one sell an investment too soon.

Research shows that investing decisions are very often made without adequate due diligence and that is what gives feeding ground to the loss aversion bias. You are not sure of fundamentals and end up either holding on to a bad investment because you don’t want to book a loss or selling a good one too soon. 

The easiest way to get over this bias is to invest after doing due research be it in any asset class or product. If you don’t have the time or ability to do this, then pick an advisor who can help you. Good advisors can not only help you pick good quality investments, but also nudge you towards better behaviour which helps you get where you want to go, in terms of your goals. 


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