Broker Check

The Fear of Losing Leads to Bad Mistakes

“I hate to lose more than I like to win”

Larry Bird


Since 2008, loss aversion has increased dramatically among investors.  For one, the post-2008 world was paradigm changing.  Interest rates fell to zero and investors had to shift their strategy in order to maintain their lifestyles.

 

Prior to 2008, investors could simply invest in US treasury securities and money market funds and get 4-6% annually with almost no risk[i].  Post 2008- you could barely get 6% in the junkiest of junk bonds[ii].  Investors had a choice:  either accept lower returns or take more risk.

 

Many chose to take more risk thinking that they had the stomach to weather the storms.  In the last five years, we’ve had three draw downs of 25% or more.  Most didn’t have the stomach that they thought they did.

 

Loss aversion is a behavioral bias that can best be described as the pain of losing is, psychologically, twice as powerful as the pleasure of gaining. 

 

This can best be exemplified by a simple analogy.  If you got a speeding ticket on the way to work that cost you $75, it would ruin your day.  However, if your boss gave you a $75 bonus, it’s doubtful you’d be jumping for joy.  The ‘pain’ of the $75 loss was greater than the ‘joy’ of the $75 gain.

 

There are two behavioral mind traps that investors tend to fall victim to.   The first loss version, which as we noted is that people hate losing more than they like winning. 

 

The second is mental accounting.  This is where people treat money differently, depending on where it came from or what it is intended for.  For example, people will spend bonuses or gambling winnings differently than they would money that they worked hard to earn.  Afterall, it is found money!

 

Past outcomes and the source of the capital leads to shorter-term rather than long-term thinking in addition to a constant evaluation of gains and losses.

 

In short, an investor who reached for return through taking on more risk and then went through 3 large draw downs in the last five years, can have loss aversion and mental accounting, creating a myopic investor.  That is someone who will constantly check their portfolio and feel deep sadness and anger when their account is down.  They will then do something they shouldn’t based on emotion.

 

But here is the paradox – markets tend to move up long-term but never in a straight line.  The S&P falls 5% or more, on average, three times per year.  And down more than 10% at least every fourteen months.[iii]  The more you check your account, the more you will see losses because these types of investors focus more on the losses. 

 

And the more you check your account, the more risk averse you become.  The more risk averse you become, the less likely you are to take the needed risk you need to take in order to achieve your goals and objectives. 

 

This ultimately leads the investor to make a BIG mistake.  Like selling or de-risking at the worst possible time. 

 

On Wednesday, November 9th, the S&P rose 5.54% for the largest one-day gain since March 2020 during the pandemic.  The Nasdaq rose 7.35% in on that day.  You almost gained a year’s worth of returns in a single market day.[iv]   

 

For those investors described above they may have made a big error and sold out just before one of the largest one-day gains in market history.  This is why staying the course is so important.

 

The big problem with selling out because of fear is that you tend to miss the largest one-day gainers where the bulk of long-term returns are made.  So making changes to your portfolio due to fear is one of the worst decisions you can make in your portfolio. 

 

We are here to help guide you through the choppy waters to reach your destination by avoiding those mistakes.

 

Right now, there is a golden opportunity not seen in nearly two decades as interest rates have risen allowing us to buy individual investment grade bonds yielding 6.0% or more.  For many clients, a 5.0% rate of return is all they need to achieve their financial goals.  Getting 6.0% in high-quality, investment grade bonds without having your capital in risky stocks or junk bonds may be an answer to chronic loss aversion and mental accounting. 

 

For many, they can live off the 6% yield produced by the portfolio.[v]  That allows investors to preserve principal and have their money working for them.

 

With our move to Charles Schwab, we now have much improved technology and the ability to buy individual investment grade corporate and municipal bonds at scale.  Many clients already have these in their portfolio acquired since the transition and more will be bought over the next few months.

 

As always, if you would like to discuss this further or have other portfolio questions, please do not hesitate to call or email me. 

 

We truly value the trust you place in us for managing your hard-earned savings.

 

Sincerely,

 

Mark J Asaro, CFA

Noble Wealth Management

 

 

[i] https://www.reuters.com/article/us-global-rates-2007/factbox-global-interest-rates-in-2007-idUKGLOBAL20071101
[ii] https://www.federalreservehistory.org/essays/great-recession-and-its-aftermath#:~:text=In%20response%20to%20weakening%20economic,the%20beginning%20of%20September%202008.
[iii] https://www.forbes.com/advisor/investing/stock-market-correction/#:~:text=How%20Long%20Do%20Market%20Corrections,a%20year%20to%20resolve%20themselves
[iv] https://www.cnbc.com/2022/11/10/stock-market-futures-open-to-close-news.html
[v] https://fred.stlouisfed.org/series/BAMLC0A4CBBBEY