Loss Aversion
Researchers analyzed thousands of stock portfolios owned by average investors. They noticed a peculiarly counterintuitive trend. 60% of the stocks that investors held underperformed the market average.
When questioned, a lot of investors said they were holding on to the stocks because they felt they were UNDERVALUED, and they probably wouldn’t sell until the stocks rebounded.
We all know we should buy low and sell high, but what the study found is that we have a powerful inclination to buy high, sustain a loss, then foolishly hang on to our losers until we just can’t stand the pain any longer. Only after we’ve endured a huge loss do we get so disgusted that we finally admit defeat.
This is the nefarious wealth-sabotaging power of LOSS AVERSION, and it is pervasive in financial markets.
One of the best ways to avoid this deviously subtle cognitive bias is to purposefully give your misguided brain a REWARD for selling a losing pick.
1) Tax Benefits
Congratulations, selling that losing pick will lower your tax bill. Bravo, you’ve outsmarted the tax man again.
2) Opportunity Costs
Fantastic, now that money is freed up so you can invest in more lucrative picks. You’ve cast off those boat-anchor choices and put your money where it can blossom.
3) Learning
Well done. By doing a postmortem on your losing choice, you learned how to make smarter picks going forward. It was a tough loss, but the wisdom you’ve gained will pay off for years to come.