You ever wonder why a gain on your monthly statement doesn’t affect you near as much as an equivalent loss? You may get a brief jolt of adrenaline to lift your spirits at the sight of a gain and not think about your investments much the rest of the day, but the sight of an equal loss can affect your entire night and cause you to lose sleep.
Michelle Baddeley, a professor of economics and finance in London, writes, “Many behavioural experiments have shown that people suffer more from a loss than they gain pleasure from an equivalent gain…This phenomenon is called loss aversion—and it has been found to apply to a wide range of people’s decisions.”1
This has been verified in psychology and neuroscience too. A Stanford professor of psychology wrote, “In [our 2007] study, we monitored brain activity while participants decided whether to take a gamble with actual money…Perhaps most interesting, the reactions in our subjects' brains were stronger in response to possible losses than to gains—a phenomenon we dubbed neural loss aversion.”2
Gains feel less significant than losses even when they are equal amounts. As an investor, that’s worth remembering. A $25,000 gain on your monthly statement will make you feel happy, but nowhere near the unhappiness you’d receive upon discovering a loss of $25,000. You probably won’t call your financial advisor after making a bunch in one month, but if you lost the same amount, you just might reach for the phone.
It’s important to know this about yourself. You are wired to feel this way when it comes to your money. Though each person experiences risk differently, and some are more risk averse than others, it is hard to be a stoic when losses hit. We might feel like a thousand bucks after a sizable gain, but we might feel like we lost a million after a loss of the same amount no matter what the size. Gains make you happy, but losses make you unhappier. Equal amounts don’t make for equal emotions.
Developing this self-awareness doesn’t mean you won’t have the same feelings the next time you lose as much as you might have gained the month before, but you’ll have a better framework of the why behind it. Experiencing inequality of emotions when it comes to investment gains and losses is a part of being human. Understanding this concept might just equip you to not let those emotions disrupt your overall financial goals.
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Sources:
- Behavioural Economics: A Very Short Introduction, p. 50.
- “What is Loss Aversion” (July 1, 2016). Accessed online: https://www.scientificamerican.com/article/what-is-loss-aversion/.