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Why you should mend your loss averting behaviour

If you are inclined to loss aversion, then chances are that you will be quick to sell investments which are profitable while holding on to the loss makers.

Ever held on to that stock or a mutual fund scheme or even a plot of land or an apartment bought as an investment for years despite the losses that are staring back at you? There is always hope when it comes to a loss-making investment, that it will bounce back. But will it?

In the wait for your loss-making investment to turn in a profit, are you letting go of opportunities that can help you generate gains? If you find this resonating with how you manage your own investments, know that you are not alone.

Behaviour specialists and psychologists have explained in various research over the years that for the human mind, pain of losing something overshadows the joy of gaining. Thus, a loss of Rs 10,000 will hurt you at least twice as much compared to the joy a windfall gain of Rs 10,000 brings to you. 

When it comes to your investments, this behaviour might compel you to remain with a loss-making investment as you continue to hope that the price will turn when you do finally sell it, rather than using whatever you get by selling it, even if at a loss, and re-investing the amount in a potentially profitable alternative.

Holding on to these losses, if indeed it is a poor-quality investment, can only make you lose more as time moves forward. Chances are you will keep hoping but will not regain the capital you spent on the investment.

This behaviour is called loss aversion. 

The dangers of loss aversion

If you are inclined to loss aversion, then chances are that you will be quick to sell investments which are profitable while holding on to the loss-makers. This only means that you are letting go of good quality investment in favour of keeping something that is not working out as expected, hence, letting go of potential future gains.

An investment is profitable in the long run if it has good value and by selling that over a loss-making one may come naturally to you but is counter-intuitive to the basics of having a good quality investment portfolio. As an extreme, if you sell all your good quality holdings, what you are left with is losses and uncertainty. 

Holding on to these losses, if indeed it is a poor-quality investment, can only make you lose more as time moves forward. Chances are you will keep hoping but will not regain the capital you spent on the investment.

How to avoid loss aversion?

Specialists advocate looking at investments in entirety rather than as individual cases. For example, if the small property you invested in is not generating any income, you may feel you have to work hard to get a rental while being unwilling to sell at a value below cost.

However, if you put this loss-making investment as part of your entire portfolio which includes stocks, bonds, mutual funds and so on, you may find that eliminating this long-term investment and reinvesting in a better alternative will in fact boost net gains in the portfolio going forward. 

Focus on your good quality investments and take this time to get rid of what is pulling your portfolio return down. However, keep in mind, when we speak of not falling prey to loss aversion, it is always about long term returns; volatility is a given in the short and very near-term period. 

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