Investing in the financial market is simple, just have resources available, have an account at a securities brokerage or bank and select the desired assets.
However, it’s not easy. There are some challenges that the long-term investor will face and the most complex ones are related to emotional and behavioral issues.
One is loss aversion, an emotional reaction that can affect financial decisions and an individual’s ability to hold investments long enough to reap the rewards.
Before continuing, the word aversion means repulsion for something or someone, in this case, for losses.
Daniel Kahneman, winner of the Nobel Prize in Economics in 2002, reports on asymmetric loss aversion and demonstrates that it is a form of protection caused by evolution.
“When directly compared to each other, the losses seem greater than the gains. This asymmetry between the power of positive and negative expectations, or experiences, has an evolutionary history. Organisms that view threats as more important than opportunities have a better chance of surviving and reproducing.”
Therefore, people do not react symmetrically to losses and gains. They place more importance on losses than on gains.
For example, a loss of R$10,000 presents a more intense pain than the pleasure generated by the gain of R$10,000.
If you invest in the variable income market, then you’ve probably already been able to live this experience.
Protecting ourselves from losses was more relevant from an evolutionary point of view than risking ourselves to obtain some gain.
Add to this the fact that the act of investing is not part of most of our evolutionary path. History suggests that the first stock exchange appeared in Belgium around 1487.
There may be disagreements about the specific date, but the reality is that from the conception of a place for financial transactions to the present day it represents a tiny portion of our past as a species.
It should be noted that loss aversion differs from fear of losing. Fear is a transient feeling, sometimes we have it and sometimes we don’t.
However, loss aversion is a deeply rooted behavioral bias, that is, it accompanies us constantly.
Kahneman addressed in perspective theory a practical case based on a coin bet. If it comes up tails, the gambler loses $100.
If heads, the bettor wins $150. The expected value of the proposal is positive, but for most people the fear of losing $100 is more intense than the possibility of winning $150.
In his study, the psychologist concluded that “the loss aversion ratio has been estimated in several experiments and is usually in the range of 1.5 to 2.5. That’s an average, of course; some people are much less loss averse than others.”
We give 1.5 to 2.5 times more weight to losses than gains. Therefore, in order to compensate psychologically, I would have to risk US$ 100 and count on a gain estimate of at least US$ 250 to US$ 350.
It is not possible to completely eliminate behavioral biases, but it is possible to learn to deal with them and minimize interference in your decisions.
And the first step is to recognize that they exist. Other points to be observed in order to improve your performance as an investor: correct assessment of the risk profile, balanced exposure between fixed income and variable income according to your objectives and risk absorption capacity, expansion of technical knowledge in the area and reduction of the time devoted to monitoring the market.
Yes, investors who follow less information, noise and quotes are more likely to hold assets, while those who follow closely tend to make worse decisions.
The experience gained over the years through practice is also an important factor.
The experience provides a mental hardening and develops skills that make it possible to deal with discomfort more effectively.
Market dynamics are cyclical, with periods of growth and euphoria, followed by declines and fear.
As an investor, it is inevitable to deal with both trends and be prepared to face different scenarios.
As already mentioned, individuals value what they currently have more than what they can earn.
To achieve a good rate of return in the long-term financial market, it is necessary to take some risks and know how to deal with price fluctuations.
Finally, professional investors have a broad view and understand the importance of portfolio asset selection, risk management and emotional control.
Thus, they manage to remain calm and follow the plan while most are being dominated by “irrational” emotions and losing their minds in moments of greater uncertainty and increased volatility.
Experienced risk takers are better able to handle losses as they have a greater emotional tolerance for price fluctuations.
Source: Moneytimes
I am an author and journalist with a focus on market news. I have worked for a global news website for the past two years, writing articles on a range of topics relating to the stock market. My work has been published in international publications and I have delivered talks at both academic institutions and business conferences around the world.
