Understanding Loss Aversion: Why Losses Hurt More Than Gains Feel Good

Why does it hurt more to lose Rs. 100 than it feels good to gain Rs. 100? This feeling is called loss aversion. It is a cognitive bias where we tend to feel the pain of loss losses more strongly than we enjoy wins. In investing, this means that people often avoid taking strategic risk because they are too afraid of losing, even if the risk could potentially translate to reward. This can prevent us from making rational, growth-oriented decisions.

• Table of contents

• Understanding the psychological basis of loss aversion
• How loss aversion affects decision-making in investments
• The emotional impact of losses vs. gains
• Example of loss aversion
• Strategies to overcome loss aversion in financial decisions

Understanding the psychological basis of loss aversion

Loss aversion comes from how our brains are wired. Psychologists have found that:

• People feel the pain of a loss more strongly as they feel the pleasure of a similar gain.
• Our brain tries to protect us from pain, even if that means missing a chance to potentially grow our money.

This forms the psychological basis of loss aversion in behavioural finance, a field of study dedicated to studying the role of emotions and cognitive biases in finance. Loss aversion a natural part of human thinking, but in investing, it can lead to suboptimal decisions.

How loss aversion affects decision-making in investments

Loss aversion in investments can lead to some common mistakes:

• Selling a stock too early just to book a small gain out of fear that the investment value will decline.
• Holding on to a losing stock for too long, hoping it will bounce back.
• Avoiding new investments after a loss, even when market sentiment seems positive.

This behaviour is not always logical. It’s driven more by fear than by facts.

Also Read: How does investor behaviour impact market conditions?

The emotional impact of losses vs. gains

Loss aversion is a common bias. When investors make a profit, they feel happy, but only for a short time. But when they lose money, the disappointment lasts longer. They may blame themselves and be afraid to invest again.
This emotional imbalance is what makes the pain of losing vs. the joy of gaining so strong. It often leads to regret and hesitation.

Example of loss aversion

Imagine you bought shares in a company at Rs. 500. The price drops to Rs. 400.

The company fundamentals are not strong, there has been some bad news about it, so the chances of recovery are not strong. Still you hold on to the losing investment because you don’t want to accept or feel the loss. But if the stock keeps falling, you will lose even more.

Read Also: Behavioral Finance: Meaning, Types, and Its Importance

Strategies to overcome loss aversion in financial decisions

Here are a few simple ways to deal with loss aversion in investments:

• Set clear goals: Focus on long-term growth potential, not short-term ups and downs.
• Follow a plan: Stick to your strategy, even during market changes.
• Use stop-losses: If you’re investing in stocks, a stop loss order can help mitigate losses.
• Think in percentages: A loss of Rs. 5,000 may sound large, but if your portfolio value is Rs 5 lakh, looking at this as a 1% drop can feels more acceptable.
• Avoid checking too often: Watching markets every day increases fear.

Also Read : Trading Psychology: Concepts, Basis and Importance

Conclusion

Loss aversion is a normal feeling, but it can lead to detrimental money choices. The pain of losing vs. the joy of gaining isn’t balanced in our minds, and that affects how we invest. The good news is that you can manage this bias by understanding it, planning better, and focusing on your long-term goals.

FAQs

What is loss aversion, and how does it affect decision-making?

Loss aversion is the tendency to fear losses more than we enjoy gains. It can lead to decisions based on fear instead of logic.

How does loss aversion impact investment choices?

It causes people to sell too early, hold on to losing stocks, or avoid investing after a loss, all of which can potentially hurt long-term results.

Can loss aversion be overcome in financial decisions?

Yes, by following a plan, avoiding emotional decisions, and focusing on long-term goals.

Why do we fear losses more than we enjoy gains?

Our brains are wired to avoid pain, and losses feel more painful than gains feel good, even if the amount is the same.

How can understanding loss aversion improve my investment strategies?

It helps you stay calm during market changes, avoid common mistakes, and stick to a long-term plan.

At Bajaj Finserv AMC, we recognise that emotions are the cornerstone of investor behaviour – not just for investors but for investment professionals too. That’s why, behavioural finance is at the heart of our investment philosophy, InQuBe, which combines the Information Edge, Quantitative Edge and Behavioural Edge. By understanding, tracking and monitoring market sentiments and our own investment biases, we seek to make mindful and strategic investment decisions. Get the Behavioural edge by investing with Bajaj Finserv AMC. Read more about InQuBe here.