Loss aversionsounds like a good thing — trying to avoid losing. What could be wrong with that? Unfortunately, if taken too far, it can actually be a threat to your long-term financial health. Loss aversion is the tendency to prefer avoiding potential losses over acquiring equal gains. We dislike losing $20 more than we like getting $20. Yet, this common bias can come with a heavy cost.
Excessive risk avoidance can hurt you when, for example, it keeps your money out of the market and tucked away in low-risk, low-interest savings accounts — where purchasing power can be eroded by inflation over time. Delaying enrollment in your employer-sponsored 401(k) plan due to fear of market downturns can cripple opportunities for future growth.
Loss aversioncan also lead to undue stress and anxiety. You stay invested, but worry constantly, which can create health and other problems. Finally, it can result in shortsighted decision making, causing you to jump ship during volatile and down markets rather than staying in for the long term. All these things can greatly compromise your retirement preparedness.
Fortunately, the fact that we’re susceptible to loss aversion doesn’t mean we have to succumb to it. And it’s especially important not to during periods of high market volatility. Here are five things you can do to fight the fear.
1. Understand it.Merely knowing about and identifying loss aversion tendencies within yourself can give you greater insight and conscious control over your decision making. Consider the potential consequences of loss aversion before making important financial decisions.
2. Take the long view.Maintaining a long-term outlook on markets can be helpful. Look at historical trends and how investments have performed over extended periods of time. Otherwise, it’s just too easy to get caught up in the latest financial fear mongering on the nightly news.
3. Don’t obsess.Set limits on how frequently you check the performance of your portfolio and limit your consumption of financial news reporting. If the daily ups and downs of the stock market make your stomach turn, try limiting your reviews to quarterly performance reports instead.
4. Get an outsider’s perspective. Speak with your advisor — someone with more experience and greater objectivity. We tend to get very myopic when it comes to our own finances; it can help to seek out the advice of experts when we lose perspective.
5. See the big picture.Take a balanced view of the overall economy, which comprises a lot more than stock market performance. Factors like increased growth, low unemployment and low interest rates are all favorable economic indicators during periods of volatility.
No one ever likes to lose, that’s for sure. And it’s perfectly normal to prefer upswings over downturns. But the lesson here is to not let fear take hold when it can compromise financial decision making and hurt your long-term best interests.