Opening investment statements – or checking values online – is tremendously gratifying when markets are rising. When markets swing in the other direction, however, the same exercise can be demoralizing – or frightening, or upsetting, or take your pick of adjective.
Whatever the feeling is, it’s not fun.
Losses hurt. In fact, losses hurt more than gains gratify.
I recently had a conversation with a client that emphasized that point particularly well.
The client called because their portfolio had declined in value, and they were concerned. That’s fair. I’m always happy to explain what’s happening in the market, how it has impacted clients’ investments, and what – if anything – we should do about it.
The client made a statement that likely resonates with many investors.
He said, “When I watch our portfolio, it seems like when the market goes up, we pick up half of those gains. But when the market goes down, we get about three-fourths of the losses.” In other words, it seemed as though the losses hit harder than the gains helped.
That sentiment, while not true in this case, is common. In fact, it’s so common that pointy-headed academics coined a fancy term for it. They call it ‘loss aversion.’
Never mind that two-dollar term. The idea is simple. Here’s one way to think about it – at least for the carnivores out there.
Imagine you are in your backyard. The sun is setting on what has been a spectacular day. You have one beautiful, flavorful ribeye on the grill, nearing perfect doneness. You can almost taste the tender, seasoned meat as wafts of smoke fill your nose with grilled goodness. You lift the lid to remove the steak from your grill and at that exact moment, your neighbor’s dog jumps up, snatches the steak, and dashes off down the street. Your steak is gone, leaving you salivating and dumbstruck.
Sit with that feeling for a while. That’s the feeling of loss.
Now, let’s pretend that same situation plays out differently. You have the same ribeye steak sizzling on the grill. A neighbor comes over with a present for mowing her lawn last week. It’s a beautiful, flavorful ribeye, just like the one you’re cooking. You thank her for the nice gift, and your neighbor walks away just as your perfectly cooked steak is ready to eat. Her dog died last week, so no worries there. You have your steak and get to eventually eat another one, too.
Sit with that feeling for a while. That’s the feeling of gain.
Now, compare those two feelings.
If a dog robbed me of my ribeye, I’d be fuming mad. On the other hand, I would be grateful for the gifted steak delivered by the neighbor. But the feeling of delight imparted by my friendly neighbor would have been far less intense than the feeling of anger towards the steak-stealing dog.
It’s the same with investments. Losses hurt more than gains feel good.
Keep in mind, unlike the steak-and-dog example, investments tend to come back. Investment losses aren’t actual losses until you make them so by selling.
The feeling of loss, though, is precisely why people panic when the market declines – particularly when the decline is significant. Losses hurt. For some, losses absolutely terrify. But successful investing demands keeping your composure while other investors are losing theirs.
Over time, the market will leave you with far more steaks than it takes. But it doesn’t always feel that way.
Justin Lueger is President of Invisor Financial LLC, a registered investor adviser firm in the State of Kansas. All opinions expressed are his own and should not be viewed as individual advice. He can be reached at firstname.lastname@example.org.