How Fear of Loss Can Hold You Back in Building Wealth

Popularized by psychologists Daniel Kahneman and Amos Tversky, loss aversion is the concept that people experience greater negative emotions following a loss than they do positive emotions from a gain of equal size.

For example, finding a ten-dollar bill on the sidewalk feels great, but realizing you dropped a ten-dollar bill on the ground—or that you overpaid for something by ten dollars—feels comparatively worse.

Fear of losses can make investors overly cautious, causing them to keep too much in cash and potentially miss out on long-term growth opportunities. Loss aversion can also drive investors to panic sell during market declines, locking in losses at the worst possible time. This bias can lead to opportunity costs when investors avoid investing available funds during periods of uncertainty - such as staying out of markets due to fears of potential losses.

Looking at the chart below, you can see the cost you would have incurred over the last 25 years if you sold after a 2% loss and stayed in cash for the respective times across the bottom versus staying invested the entire time.

This is very common - feeling a small decline is “just the start”.

For example, during the 2020 market downturn, many investors panicked and sold their holdings at the bottom, causing them to then miss out on the rapid recovery, highlighting how loss aversion can lead to poor timing.

Historical market corrections show that patient investors who stayed in the market through temporary declines generally benefitted in the long run. To put it another way - the fact that it is challenging to stay invested is exactly why investors are rewarded. If it was easy, it wouldn’t pay so much.

Shean