When you’re investing, one of the most difficult elements to overcome can be loss aversion.
Loss aversion is a behavioural bias, first identified in an academic paper in the Journal of Risk and Uncertainty by psychologist Amos Tversky and Nobel prize-winning economist Daniel Kahneman.
In their paper, Tversky and Kahneman conducted a range of studies on the way that people perceive gains and losses.
From this research, they found that the negative feelings of losses could be around twice as powerful in their effect on study participants’ future behaviour than the positive feeling of achieving gains.
What this means is that, as the pain of losing is more powerful than the satisfaction of gains, people would rather avoid losses entirely than target gains at all.
You may well be struggling with this sense of loss aversion. In fact, you may even have noticed that your fear of losing out is directly affecting your investment strategy, preventing you from taking on as much as risk as you’d like.
That’s why it may be sensible to consider strategies that can help you deal with loss aversion, ensuring that you don’t miss out on potential returns. Here are a few methods you can consider to help you do exactly that.
Build a balanced portfolio
A good place to start managing loss aversion is to build a portfolio with the right level of risk for you. After all, the key to successful investing is not to do what others are doing, but rather what works for you in your circumstances.
It’s often sensible to create a diversified portfolio, containing different asset classes held across various industries, sectors, and geographical locations with varying levels of risk.
This can help to reduce the risk of all your investments losing value at once, which in turn can assist you in managing your aversion to loss.
For example, if you built a portfolio made exclusively of oil stocks and the entire sector experienced a dip in share prices, all your investments could lose value.
But, if your portfolio was made partially of oil stocks and perhaps some renewable energy stocks, this could reduce the risk of your entire portfolio losing value at once.
Bear in mind that this is never guaranteed, and you could end up losing more than you invested. Even so, diversification and tailoring your risk to your personal preferences can be good methods to manage your aversion to losses.
Make changes to your portfolio less often
As strange as it may sound, if you’re struggling with loss aversion then you may actually benefit from making changes to your investments less often.
Sometimes, loss aversion can lead you to change your investment strategy in response to short-term swings in value.
But actually, past market data shows that the best course of action with investments is often to take a long-term outlook.
According to Nutmeg data analysing market performance between January 1971 and December 2021, holding a randomly chosen global stock for at least 10 years during that period would have given you a 94.15% chance of making a positive return.
Meanwhile, holding an investment during this period for 13 years took the probability of losing money at all to nearly 0%.
That means, if you find yourself making snap decisions in response to dips in value, it may be best to leave your money invested and try to avoid the temptation to check it constantly.
This doesn’t mean not actively managing your investments; on the contrary, it’s important to keep an eye on how they’re performing.
Even so, it can be useful to remember that, generally speaking, investments perform best when given time to do so.
Of course, just because this is true historically, it does not mean it will continue to be. Past performance is not an indicator of future performance.
Work with a financial planner
Above all else, if you’re still finding it difficult to ignore the anxiety of loss aversion in your investment strategy, perhaps the best thing you can do for yourself is work with a professional financial planner.
By working with a professional, you’ll have someone in your corner to discuss your investments with and help you make decisions without the bias of loss aversion affecting you.
They can provide guidance and make suggestions throughout your investment journey that can ensure your diversified portfolio is appropriate for you in terms of risk and reward.
Crucially, a planner can monitor the performance of your investments, showing where you can refine your strategy even further.
Work with us
At Cordiner Wealth, we can help you build a diversified portfolio with an appropriate level of risk for you. We’ll regularly review your investments for you, checking that they’re on track, and make any adjustments where necessary.
If you’d like to find out how we could help you, please email email@example.com or call 0113 262 1242 to get in touch.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.