Loss Aversion

Research by psychologists Daniel Kahneman and Amos Tversky suggested that, for many people, losing a sum of money feels roughly twice as bad as gaining the same amount feels good. This imbalance affects many financial decisions.

For example, many people will turn down a coin toss that offers a 50% chance of winning 110 and a 50% chance of losing 100, even though the bet has a positive expected value. The potential loss looms larger than the slightly bigger potential gain.

In investing, loss aversion can lead to several costly behaviours. Investors may hold on to losing investments too long, hoping to avoid realizing a loss, while selling winning investments too early. They may avoid investing in shares altogether because of fear of short-term losses, even when they have a long time horizon. They may panic and sell during market falls.

Loss aversion is a central idea in behavioural finance and prospect theory. Being aware of it can help investors make more balanced decisions, for example by focusing on long-term goals, diversifying, and following a plan rather than reacting emotionally to short-term changes in value.