Money Basics: Why you’re scared of losing money
24 April 2023
If you’ve ever lost money on an investment, the chances are you’ll remember exactly when, and exactly how much.
The same is not always true when you have made money, because the pain of losing money is twice as powerful as the pleasure of gaining.
In behavioural finance, this is called ‘loss aversion’.
What is loss aversion?
People prefer avoiding losses than acquiring gains, and are more prepared to take risks to do so.
That might not sound logical, cause we are taught that with greater risk comes greater potential reward, but by avoiding loss, you are taking on some less obvious risks.
The first is inflation risk.
By avoiding losses, you are more likely to save into a cash account.
Cash may seem safe, but interest payments have been low for a long time, and although creeping up, they are wiped out by double digit inflation.
Leaving your money in cash means that the real value of that money will diminish over time.
The second is concentration risk.
By seeking to reduce your risk you are more likely to invest in what is familiar.
That could mean cash and investments in your own territory, like government bonds, which would lead to a currency concentration.
For example, the value of sterling fell by 10% after Brexit. Taking on more apparent risk by investments in other currencies could have protected the real value of your money from currency drops.
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