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Is Fear Causing You to Lose Money?

Some investors’ fear of losing money compels them to completely avoid the stock market and other volatile investments. This phenomenon is often called “loss aversion.”

People suffering from loss aversion will sometimes wait until they see the market has gone up a lot, and then they invest. They forget about history, and just believe that the economy will continue strengthening. They often buy into the market at a high, and then when it tumbles, as it inevitably does, they sell out. As any financial advisor can tell you, selling when the market is low and buying after it peaks is a formula for failure.

Investors trying to time the market may cause their own problems. It often emerges that if they had just stayed in the market when it went down and continued to stay invested when it recovered, they may have kept – or increased – their portfolios. As Nobel Prize winner Professor Daniel Kahneman says, “The main implication for loss aversion in investing is that you have to think about what you could sustain without changing your mind or without changing course.” In other words, if you want to invest in the stock market, which could turn out to be a wise choice, you must have the stamina to deal with the volatility. Naturally, past performance is no guarantee of future returns.

Fear of risk

While on the surface it may seem wise to avoid risk, investors who shy away from any level of risk in their portfolio may face problems. Total avoidance of risk may mean limited returns, or even worse, losing the “real value” of their investments. Inflation can cause you to lose the real value of your money if it increases at a greater rate than the interest your money earns. For example, if you could buy a basket of groceries today for $100, it might cost you $105 next year if inflation is 5%. If your investments don’t grow that much, you will have lost buying power. Your fear of loss can become a self-fulfilling prophecy when it holds you back from making more logical, measured decisions.

Regardless of how you characterize yourself as an investor, if you understand the psychological barriers that cause people to make poor decisions, you should be able to plan logically. Choose a financial advisor who can help you assess your ability to handle volatility and choose appropriate investments based on your needs and tolerance for risk.

For more about loss aversion, read this.

Douglas Goldstein, CFP®, investment advisor, is the co-author with Grandmaster Susan Polgar of Rich As A King: How the Wisdom of Chess Can Make You a Grandmaster of Investing

Profile Perspectives is a personal finance blog based on articles Doug Goldstein, CFP®, director of Profile Investment Services, Ltd., published in The Jerusalem Post. The information posted is purely informational and does not constitute investment or tax advice. Advertisements on the site are neither endorsements nor recommendations. Consult your professional advisors before making any investments based on articles or advertisements. Securities offered through Portfolio Resources Group, Inc., member of FINRA, SIPC, MSRB, FSI. Accounts carried by Pershing LLC., Member NYSE/SIPC, a subsidiary of The Bank of New York Mellon Corporation.

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