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Loss aversion tells us that losses hurt twice as much as gains feel good. Myopia deals with the fact that people have a tendency to evaluate outcomes on a frequent basis. Put them together and these two behavioral biases can wreak havoc on your portfolio because the more often you monitor your investment results the more likely it is that you’ll see a loss, and thus, suffer from loss aversion.
This is one of the reasons so many investors make mistakes during bear markets. Down markets force people to assess the damage in their portfolios more often, which leads to pain from seeing losses, which leads to even more monitoring of performance. It becomes a vicious cycle.
One of the reasons for this is because of the difference between the nature of bull and bear markets. There’s an old saying that stocks take the escalator up but the elevator down. Bull markets are fairly slow and methodical. Bear markets are violent and come in waves. Bull markets take time to climb the wall of worry while bear markets can wipe out a decent amount of those gains in a hurry.
Comments
Good stuff! Thanks Ted.