{"id":5151,"date":"2024-03-24T12:07:59","date_gmt":"2024-03-24T06:37:59","guid":{"rendered":"https:\/\/incredmoney.wpcomstaging.com\/?p=5151"},"modified":"2025-02-19T06:30:26","modified_gmt":"2025-02-19T06:30:26","slug":"are-you-also-a-loss-averse-investor","status":"publish","type":"post","link":"https:\/\/devblog.incredmoney.com\/blog\/are-you-also-a-loss-averse-investor\/","title":{"rendered":"Are you also a Loss Averse investor?"},"content":{"rendered":"

Back in 1989, Peter Lynch, one of the biggest investors, got a call from none other than Warren Buffet. He called for a very simple purpose. He wanted to use a quote by Peter Lynch from his book, <\/span>\u2018One up the Wallstreet\u2019<\/b> in his Berkshire Annual Report.\u00a0<\/span><\/p>\n

The quote was, <\/span>\u201cSelling your winners and holding your losers is like cutting the flowers and watering the weeds.\u201d <\/i><\/b>\u00a0<\/span><\/i><\/p>\n

This is a classic case of the <\/span>Disposition effect <\/b>\u2013 Where we as investors sell our profitable positions while holding on to the losing ones.\u00a0<\/span><\/p>\n

Have a look at this graph below –\u00a0<\/span><\/p>\n

\"Disposition<\/p>\n

Disposition effect <\/b>happens because of two common behavioural biases – <\/span>Risk Aversion <\/b>(when you want to sell your winners) and<\/span> Loss Aversion <\/b>(when you resist realizing your losses).\u00a0\u00a0<\/span><\/p>\n

Let\u2019s talk a bit about <\/span>\u2018Loss Aversion\u2019<\/b> today.\u00a0\u00a0\u00a0<\/span><\/p>\n

In 2019, Zerodha, a leading broker, published data stating, <\/span>\u201cNearly 2 lakh of our clients hold Yes Bank with an unrealized loss of over 59%; 1.25 lakh hold Ashok Leyland with loss of 40%; over 1 lakh hold Tata motors with over 51% loss.\u201d <\/span><\/i>This is classic example of \u2018Loss Aversion\u2019.<\/span><\/p>\n

Loss aversion is a psychological phenomenon where people <\/span>tend to feel the pain of losses more strongly than the pleasure of equivalent gains<\/i><\/b>. In short, it means we would rather avoid losses than acquire equivalent gains.<\/span><\/p>\n

What makes us afraid of losing money when we invest?<\/span><\/p>\n

We get <\/b>Married<\/i><\/b> to our Investments!<\/b><\/p>\n

This happens to the best of us. When we decide to invest in a stock after a lot of research, <\/span>we become emotionally attached<\/b> to its outcome. During periods of underperformance, we tend to actively seek out reasons for the stock’s potential recovery (also known as <\/span>Confirmation bias<\/b>).<\/span><\/p>\n

We consider it as a <\/span>personal failure to sell a loss-making stock<\/b>, so we hold on till the time it breaks even or starts making profits. Sometimes we keep <\/span>averaging the stock<\/b> at lower levels and accumulate more units than what we had originally desired.<\/span><\/p>\n

After experiencing a significant decline in a specific stock’s value, a common tendency for many investors is to sell the stock once it has rebounded back to the Cost price (i.e. on a <\/span>No Profit No Loss basis<\/b>).<\/span><\/p>\n

This Loss Aversion, many times however, leads us into a <\/span>spiral of uncontrollable losses<\/b> which makes it even more difficult to break even (Refer to the graph below).\u00a0\u00a0<\/span><\/p>\n

\"Percentage<\/p>\n

As an investor, how can you prevent yourself from falling prey to Loss Aversion?<\/b><\/p>\n

Detachment from the Cost Price:<\/b> We get anchored to the Cost Price of our investments which then guides our decision making. If the factors supporting the decision to hold a stock have deteriorated, we must consider exiting the position irrespective of what the Cost Price was.<\/span><\/p>\n

Put a Stop Loss:<\/b> We should establish a predefined <\/span>stop loss rule<\/b>, such as setting it at 10% below the cost price. It’s important to be disciplined: once the stock reaches the stop loss level, we exit the position. Think of a stop loss like the saying, <\/span>‘A stitch in time saves nine.’<\/b> Trust me, as stock prices decline further, it becomes progressively more challenging to exit the position. For instance, selling a stock at a 20% loss is far more difficult than at 10%, and the challenge only increases from there.\u00a0<\/span><\/p>\n

So, are you also prone to this Loss aversion bias? Then I hope this piece helps you avoid it in the future.<\/span><\/p>\n

 <\/p>\n

Till the next time,<\/span><\/p>\n

Vijay<\/span><\/p>\n

CEO \u2013 InCred Money<\/span><\/p>\n

P.S. I share my thoughts on Investing and the Economy regularly. You can follow me here.<\/span><\/p>\n","protected":false},"excerpt":{"rendered":"

Back in 1989, Peter Lynch, one of the biggest investors, got a call from none other than Warren Buffet. He called for a very simple purpose. He wanted to use a quote by Peter Lynch from his book, \u2018One up the Wallstreet\u2019 in his Berkshire Annual Report.\u00a0 The quote was, \u201cSelling your winners and holding […]<\/p>\n","protected":false},"author":4,"featured_media":5156,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"inline_featured_image":false,"footnotes":""},"categories":[5,4],"tags":[10],"class_list":["post-5151","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-newsletter","category-personal-finance","tag-newsletter"],"acf":[],"yoast_head":"\nAre you also a Loss Averse investor? - InCred Money<\/title>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/devblog.incredmoney.com\/blog\/are-you-also-a-loss-averse-investor\/\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"Are you also a Loss Averse investor? - InCred Money\" \/>\n<meta property=\"og:description\" content=\"Back in 1989, Peter Lynch, one of the biggest investors, got a call from none other than Warren Buffet. He called for a very simple purpose. 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