This week, I’m talking about behavioral finance. An incredibly important topic when it comes to your money and your retirement, yet at the same time it’s something that few people really, truly understand. Essentially, behavioral finance looks at how your psychology, your emotions, and your biases impact your decisions and your behavior when it comes to your money. 

Today, I’m talking about one of the most important concepts in behavioral finance - loss aversion. 

Loss aversion is a bias that most of us share. It states that we often feel more extreme and negative feelings over losses vs. the positive feelings we feel about gains. 

Using gambling as an example, you’re likely to feel the pain of losses even when you come out ahead. If you win $1000 and then lose $900 in the next hand, it feels like a net loss even though you are actually ahead by $100. 

Loss aversion is a problem because of the pain of loss can drive us into emotional and bad decisions. If your portfolio drops by 10% you may be tempted to panic and sell, because the pain is too great, that you just can’t take it any longer. I’ve had clients call me over the years after bad days in the stock market, or after they open their statement and see a big drops from last month’s value. Conversely, when you see your portfolio is up 10% or that you made lots of money in the last month in your investment portfolio, you’re much more likely to react like “meh, that’s nice”. 

In order to overcome the loss aversion problem, the first step is to recognize that you’re wired to experience losses in a much more extreme negative way. Just understand that you and I and everyone else is prone to feel worse about losses than we feel good about gains is an important first step. 

A second and important next step, especially if you are prone to make rash, emotional decisions, is just to avoid the temptation to feel bad in the first place. For your retirement portfolio, this means tracking your portfolio value less often. If you look at your portfolio everyday, you’ll see losses all the time. If on the other hand you only look at your portfolio balance a few times a year, you’re much more likely to see a gain and not expose yourself to the pains of loss aversion. 

That’s it for today. Before you go, please take a minute to leave an honest review for the One Minute Retirement Tip in Amazon or iTunes. Thanks for listening. My name is Ashley Micciche and this is the One Minute Retirement Tip. 

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