Loss aversion
A loss hurting more than an equal gain pleases, which makes a fair bet feel unattractive and losing positions feel worth holding.
Where you will meet it
Loss aversion appears in 6 learning outcomes on the CFA syllabus. A few of them:
- Set out the behavioural biases that investors commonly show
“Loss aversion makes a loss hurt more than an equivalent gain pleases, which is why losing positions are held and winning ones sold — the disposition effect.”
- Explain how a client's requirements and attitudes toward particular investment risks can be built into an asset allocation
“Behavioural preferences such as loss aversion may justify goals-based sub-portfolios that clients understand.”
- Discuss how behavioural factors shape the decisions of an investment team and propose ways to limit their influence
“Groupthink and conformity suppress dissent, especially when a senior member speaks first; overconfidence and the illusion of control encourage concentrated bets; confirmation bias filters evidence toward existing views; anchoring ties forecasts to earlier numbers; loss aversion and the disposition effect delay selling losers; and herding pulls the team toward consensus positions.”
- Tell apart emotional biases and cognitive errors
“Emotional biases arise from feeling and impulse: loss aversion, overconfidence, self-control, endowment, regret aversion, status quo.”
Practise it
Practise loss aversion until it is automatic: questions that explain every wrong option.
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