Loss-Aversion Bias

Loss-Aversion Bias

Have you ever bought a stock, and almost immediately it started increasing in price, at which point you’re pleased that you have a nice gain!  Then, something happens in the news or the market that makes you nervous so you go ahead and sell this stock to realize the gain.  A few months go by, and the stock that you so proudly sold for a nice gain is up even further and you think to yourself, “darn, I shouldn’t have sold that stock!”

Or how about another scenario where you bought a stock and it almost instantly starts to go down.  You don’t sell it right away, because you don’t want to take the loss, so you continue holding it, and eventually six months goes by and the stock has continually gone down even further.  You think to yourself, “I should have sold that stock a long time ago when it was only down slightly!” At this point you own some big loser that you don’t want to get rid of in hopes that it comes back one day.

We’ve probably all experienced both of these situations, but you should be aware of this phenomenon and learn from it, hopefully helping you avoid these mistakes in the future and leading to better investment decisions.  These two examples are documented and have been studied for many decades—they are referred to as “loss-aversion bias”. Investors are often too quick to take gains, because it feels great to lock in gains before they might disappear, and at the same time, hang on to losers way too long in order to avoid a dreaded loss.

We should try to learn from this to let our winners “run”, and be patient in order to hopefully achieve further upside gains, and at the same time be quick to sell losers—as hard as it is to do—in an effort to avoid further future losses.

One could apply these concepts to the stock market in general today, instead of only on an individual stock basis.  The market has been going up for several years now, so I hear often times from my clients that we’re “due” for a market pullback because it’s been going up for so long.  Or, with the China tariff situation, and the election coming up next year, and the Fed deciding what to do with interest rates, investors are potentially exhibiting these biases today by wanting to sell out of the market now.  It might prove prudent to be patient, and let this bull market continue to “run” before exiting. Talk with your Financial Advisor about the right strategy for your portfolio.

Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. No strategy assures success or protects against loss. Investing includes risks including loss of capital.

BIO: Born and raised in the Central Florida area, Eric Greenhow strives for excellence — embodying the spirit and core values of Allen & Company. He is nationally recognized for his industry leadership and community service, and is a Chartered Financial Analyst® and CFP®. For more information about Eric and the Allen Investments Team, call 863.294.7411 or visit AllenInvestments.com/GoGreenhow.