What is loss aversion?

What the researchers found

In 1979 the psychologists Daniel Kahneman and Amos Tversky described how people choose when the outcome is uncertain. One of their findings was that a loss weighs more than a gain of the same size. Losing $1,000 hurts more than winning $1,000 feels good.

For anyone who owns stocks this matters for a simple reason: prices move all the time, and a large share of the moves are down.

The more often you look, the more losses you see

This is how often a look at the price showed a loss against the look before, depending on how often you look:

The S&P 500 has risen 415 times since 1928, without dividends. Even so, 46% of its days showed a loss. Year by year it was 32% of the years. The prices are the same; only the looking differs.

With loss aversion, each of those days weighs more than a day up. Someone who checks every day gets almost as many bad days as good ones, and the bad ones count for more. The economists Shlomo Benartzi and Richard Thaler called this myopic loss aversion.

The fall and the way back

Loss aversion is about the feeling, and the arithmetic does not help. A fall of 50% needs a rise of 100% to get back. That sum, and the deepest falls of the largest companies, are in the lesson on how much you can lose. How often the market has lost money over one to thirty years is in the lesson on how long you need in the stock market.

What the feeling can lead to

Loss aversion can make people sell after a fall to stop the feeling, or never buy a stock at all. It can also make them hold on to a stock that has fallen, to avoid taking the loss. That last one is the subject of the lesson on the purchase price.