The effects of loss aversion bias in investing.

Biases are the filters through which we make decisions about everything—from what movies we watch, to what we have for lunch, to what we do with our money. All thoughts are filtered this way. In fact, it's impossible to make a purely unbiased decision.

What is loss aversion bias?

Loss aversion bias drives us to prioritize avoiding losses over earning gains. But when it comes to money matters, loss aversion can lead to portfolios that are potentially too conservative. People often need an extra—and sometimes significant—incentive to take financial risks that might result in a loss.

Loss aversion is a major reason why many investors underperform the market.

The problem: A conservative portfolio may sacrifice the growth potential you need to reach your long-term goals.

A graph shows two lines representing the ten-year growth, from 2014 to 2024, of two portfolios that start out with $10,000. A conservative portfolio that is 50% stocks and 50% bonds shows steady growth and reaches a value just above $200,000. An aggressive portfolio that is 80% stocks and 20% bonds grows at a somewhat faster rate and reaches a value of approximately $280,000 by the end of the period.

Loss aversion is the reluctance to realize a loss because the emotional jolt of said loss is about twice as powerful as the joy from a gain.2

In the down year of 2022, the average equity investor lost 21.17% during a year when the S&P 500® Index lost 18.11%, a gap of 3.06%.3 This may be due to investors selling stocks out of fear and missing out on any market rebound.

In 2022, many 401(k) participants put new money into assets they presumed to be safer while pulling money out of equities.4

Keep biases in check by working with a Schwab investment professional.

A Schwab investment professional can be a sounding board for your investing goals and decisions, working with you to overcome any emotional or cognitive biases you may have. We can work with you on your terms, whether it's building a one-time plan, providing ongoing support, or introducing you to new products and solutions.

Put your new insights into action with either managed or self-directed solutions.

Learn even more on our behavioral finance podcast.

Choiceology®

Wharton professor Katy Milkman shares true stories involving high-stakes moments and explores the latest research to help you make better judgments and avoid costly mistakes.

Choiceology with Katy Milkman podcast presented by Charles Schwab

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