Known as the fear of loss that leads to a withdrawal of capital at the worst possible time, this bias is also known as “panic selling.” Loss Aversion Bias is a powerful emotion that investors need to learn to control. Unfortunately, investors have a very poor track record in that regard and have repeatedly demonstrated one of the primary by-products of this bias, selling their assets while the prices of those assets are going down.
Because most investors rarely have good insight into what they actually own in their investment portfolios and why the companies that they own are in their portfolios to begin with, they tend to sell assets while prices are dropping. This has been substantiated by the famed Dalbar Study, which has repeatedly documented this destructive investor behavior. The question is why?
At Nepsis®, we believe this is due in large part to the fact that many investors own Mutual Funds or ETFs. As a result, they are unaware of the underlying holdings that compose their funds, of which many are sound companies with solid fundamentals. Investors simply focus on the current value of their portfolio as a whole, failing to have knowledge or conviction over the companies that they own.
Then, during the midst of a market event, such as a correction, investors succumb to Loss Aversion Bias and, without the aforementioned knowledge of or conviction in the companies that are in their portfolios, make the emotional decision to sell. Usually, broad market selloffs bring the price down of most stocks simultaneously. Investors, because of their naïveté as it pertains to the contents of their portfolios, sell what oftentimes turn out to be perfectly fine businesses at discount prices to a willing and savvy buyer who is looking for hidden value.
In the process, investors end up regretting their actions as the stock prices of sound companies tend to rise over time. Psychological studies have shown that the emotions created by Loss (money or otherwise) are twice as strong as those emotions garnered by Gain; making Loss Aversion a bias that investors need to both understand and then come to recognize in their own actions.
So how do investors overcome this powerful bias? In our estimation, it starts with two points of clarity: the knowledge of what is owned in one’s portfolio and the rationale as to why it is in the portfolio to begin with. If investors combine these two important ingredients, they will have the elixir to Fear and thus the remedy for the Loss Aversion Bias.
Advisory Services offered through Nepsis, Inc.; An SEC Registered Investment Advisor.
