Why Losing Feels Worse Than Gaining Feels Good

I recently came across this simple but beautiful chart from financial author Carl Richards.*

This idea that we feel losses more than we feel gains is commonly referred to as “loss aversion.” Renowned Psychology and Economist Daniel Kahneman says “losses loom larger than gains.”

Here are a few real-world examples -

(1)   Losing a 20-dollar bill feels worse than finding a 20-dollar bill feels good. 

(2)   A free trial for grocery delivery makes it hard to lose that convenience when the trial ends.

(3)   Most people won’t take this bet – tails you lose $100, heads you win $150 (in fact studies show, the majority of people have to be offered 2x the amount of the potential loss to take the bet).

This is a natural human bias that is meant to protect ourselves from devastating losses. However, it often clouds our judgment and doesn’t allow us to take calculated and prudent risks to grow our wealth. If we could experience an equal amount of pleasure from gains, the euphoric feeling of watching your portfolio grow for a decade or longer would have an aftereffect that would ease the pain of seeing your portfolio lose a quarter of its value in a year. But a decade goes by, the growth goes barely noticed, and when the loss occurs, the event imprints itself in our mind and impacts future financial behaviors.

This concept of loss aversion can be seen everywhere in investing.

An investor avoids stocks that have historically quadrupled or more over their lifetime so they can avoid ever experiencing a temporary 50% loss.

An investor that bought a stock at $100 won’t sell it when it drops to $80, but an investor who bought the stock years ago for $20 will sell it. Both investors own the same stock but the former doesn’t want to realize a loss and the latter is happy realizing a gain.

An investor sells a stock that has only gone up slightly even though it is likely to go up further just so they can avoid ever experiencing a loss.

In many areas of personal finance, simply being aware of something does not cure us of it – and this is no exception. But understanding our biases makes us more open to learning new information that can change our perceptions about investing, and help us make better, more rational decisions.

Thank you for reading,

Alex

This blog post is not advice. Please read disclaimers.

1 - Richards, Carl. “Overcoming an Aversion to Loss.” The New York Times, The New York Times, 9 Dec. 2013, www.nytimes.com/2013/12/09/your-money/overcoming-an-aversion-to-loss.html.