Major market events typically happen every few years with long stretches of relative calm between. However, in recent times we’ve seen more stock market volatility than usual.
Feeling some level of discomfort during market uncertainty is completely natural – volatility can cause even the most experienced investor to feel anxious. But allowing fear to drive your investment decisions could prevent you from achieving your long-term goals.
Society loves a label and this emotional reaction is no different – in this case, it’s “loss aversion”
In 1979, psychologist Amos Tversky and economist Daniel Kahneman carried out a study and observed that participants felt the pain of a loss twice as strongly as the pleasure of a gain.
Feeling losses more keenly than gains could affect how you manage your finances.
When it comes to investing, you might find that the fear of losses is more powerful than the lure of achieving returns. This, in turn, could lead you to:
- Hold too much wealth in cash – When markets are volatile, it can be tempting to hold more of your wealth in cash. Though this could reduce your risk of making a loss, over the long term, the effects of inflation could erode the real-terms buying power of your money.
- Refuse to sell shares that are making a loss – Not all investments will work out. In such an event, it’s often better to cut your losses by selling and reinvesting elsewhere. Loss aversion could persuade you to wait for a change in fortune. But staying invested in struggling stocks could result in a small loss turning into a much larger one.
- Lower your risk tolerance – While you need to be sensible about the level of risk you expose your wealth to, opting to take less risk might lead you to avoid investments which could offer greater returns.
Strategies for overcoming loss aversion
- Focus on your long-term goals
Instead of fixating on short-term market fluctuations, focus on your long-term goals.
Reminding yourself why you invested your money and thinking about your big-picture plans could help to lessen the emotional impact of any short-term losses.
Remember too that markets typically bounce back, often making the greatest gains in the days immediately following a fall.
While market fluctuations are inevitable, focusing on your long-term goals can help carry you through periods of volatility.
- Keep calm and carry on
When markets are underperforming, it’s natural to feel anxious about your portfolio.
History shows that stock markets typically trend upwards over time, and short-term dips usually recover relatively quickly.
The chart below shows how the ISEQ All Share has performed over the last five years.
Source: DAVY [1]
Despite various dips, it has routinely recovered and continued to rise.
- Chat things through with me
If you’re worried about the market or how your portfolio is performing, please get in touch.
I’ll be happy to listen to your concerns and shed light on the bigger picture. Sometimes, things can appear to be far worse than they are in reality – especially when financial journalists are keen to create fear.
Read more: Breaking news: Beware the 24/7 news cycle – it could be bad for your wealth
Talking things through and understanding how events are shaping the markets can help put things in perspective and allay your worst fears.
Finally, remember that your investment portfolio is tailored around your capacity for risk and aligned with your long-term goals.
Whether or not you reach out for support, each year we’ll meet to review your portfolio and ensure your investments remain on track.
If you’re worried about loss aversion or simply want a fresh take on your investment strategy, I’m here to help.
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