Behavioral Finance: The Nature of Losses


When I was nine or ten years old, my grandfather taught me how to play poker.  He brought out his loose change jar and counted out twenty five pennies for each of us, and walked me through a simple game of five-card draw.  I enjoyed learning the hierarchy of winning hands, and the strategy of deciding which cards to hold and which to throw away.  I loved seeing my shiny pile of pennies slowly build up.  What I wasn’t prepared for was how much it stung when I lost most of them back to Grandpa on a lucky draw of three of a kind.  I was so upset to see them go  – and they weren’t even my pennies to begin with!

I was never a gambler at heart, even then.  And as I remind everyone who asks me for a tip on a hot stock, gambling and investing are not the same things.  My job as an investment adviser is to help clients protect and grow their wealth in a prudent and measured manner.  But this very human reaction to losses definitely plays out in the savings and investment arena in a multitude of ways.  I think part of the reason we feel losses so keenly is because they can happen quickly, while sustainable gains take time to build.

So often our natural human emotions lead us to respond to negative events quickly and often rashly rather than to apply our rational side and anticipate the events that are likely to come next.  This tendency points to a key reason why it can be so advantageous to partner with an adviser when making financial decisions.  While many wealth advisers like myself spend a great deal of time studying the financial markets and building expertise so that we can help you to mitigate losses in the first place, a major part of our job is also to help you maintain a long term view that looks beyond recent setbacks – to be the little voice on your shoulder, reminding you to stay the course.  Market corrections are disconcertingly common but responsible planning renders their effects to be much less harmful.

At Legacy Trust we work with our clients to ensure that near-term cash flow needs are planned for and are not subject to stock market volatility, whether that means those needs will be met from fixed income investments, equity dividends, hedging strategies or some combination of factors as each set of client circumstances dictates.  While human nature will always lead us to feel market losses keenly and painfully, keeping a long-term perspective when it matters most (especially when it runs contrary to our instincts) will ultimately lead to financial success.

NPR’s All Things Considered did a segment last week on this topic – here’s a link if you’d like to listen.