What is Myopic Loss Aversion?
We fear losses more than we value gains.6 In investing, this means that the pain of losing money exceeds the pleasure of gaining it. We feel the agony of a falling portfolio more intensely than the ecstasy of a rising one.
Thus, we experience myopic loss aversion – we focus on avoiding short-term losses at the cost of achieving long-term gains. To avoid the pain of short-term loss, investors sell during downturns, thus damaging their prospects for long-term returns.7
Loss aversion is deeply rooted in how our brains work. There is evidence that our painful emotional reaction to the prospect or reality of experiencing loss arises from the fear center of our brain and involves the amygdala, which plays a key role in regulating our behavior and can even override our rational responses.8 This means that losses can cause serious emotional distress and overwhelm any other thoughts or feelings, driving us to take any action we can to make the pain stop.
In other words, loss aversion can be a highly potent emotion that can drive us to behave in ways that our rational mind knows to be counterproductive. Our feelings can overwhelm us and make us act in uncharacteristically short-sighted ways. What’s more, some people may be more vulnerable to this effect than others.
6 Behavioral Economics. Myopic Loss Aversion. N.D.
7 Plancorp. Myopic Loss Aversion. December 2, 2020.
8 Peter Sokol-Hessner and Robb B. Rutledge. The Psychological and Neural Basis of Loss Aversion. November 29, 2018.
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