Glossary · Economic ideas
Loss aversion
Loss aversion is the tendency to feel a loss about twice as strongly as a gain of the same size, so people often avoid risks even when the odds favor them.
Also called: prospect theory, fear of losses, myopic loss aversion
S&P 500 with dividends. Years with a loss: 25%. Ten-year stretches: 5%.
In plain words
Someone offers you a coin flip: heads, you win $110; tails, you lose $100. On average you would come out ahead, yet most people say no. Losing $100 simply feels worse than winning $110 feels good. That is loss aversion.
The psychologists Daniel Kahneman and Amos Tversky measured it in the 1970s: for most people a loss hurts about twice as much as an equal gain pleases. They built it into prospect theory, which won Kahneman the Nobel prize in economics in 2002.
It explains a lot of money behavior: holding on to losing stocks to avoid “making the loss real”, selling winners too early, keeping too much in cash, and checking an account so often that every dip hurts.
Example
Checking too often
Loss aversion stings more the more often you look. Here is how often US stocks, the S&P 500 with dividends reinvested, showed a loss since 1926, depending on how long you held them.
- Check every month: a loss in 35% of months.
- Check once a year: a loss in 25% of years.
- Check once a decade: a loss in 5% of ten-year stretches.
- Twenty-year stretches that ended with a loss: 0%.
Same investment, very different feelings. Economists call it myopic loss aversion: the more often you look, the more losses you feel. (Before inflation; the past is no promise.)
One level deeper
Prospect theory (1979) says people judge outcomes as gains or losses from a reference point, usually what they have now or what they paid, not by their total wealth. Losses loom larger than gains, and people take risks to avoid a sure loss but avoid risks when a gain is sure.
Related effects: the endowment effect (people ask more to sell a mug they own than they would pay to buy the same mug) and the disposition effect (investors sell winners too soon and hold losers too long). Both come from treating losses as extra painful.
Some newer studies find the effect small for small amounts, or absent in some settings, so how strong loss aversion is remains debated. But that people weigh losses heavily in money decisions is one of the best-known findings of behavioral economics.
How often US stocks showed a loss, by holding period
The share of all holding periods since 1926, one starting in every month, that ended with less money than they began with, dividends reinvested. The longer the holding period, the rarer the loss.
The numbers behind the chart
| Periods ending with a loss | |
|---|---|
| 1 month | 35% |
| 1 year | 25% |
| 5 years | 12% |
| 10 years | 5% |
| 20 years | 0% |
Why it matters
It drives many costly money habits: selling in a panic after a fall, refusing reasonable risks, holding losers too long.
It helps explain why investors demand a higher return from stocks than from safe bonds: stocks show losses often, and losses hurt.
Marketers use it: “don’t miss out” and “you’ll lose your discount” work better than the same offer described as a gain.
A common mistake
Myth: Avoiding losses is the same as being careful.
In fact: Avoiding every possible loss has costs too. Cash never shows a loss on paper, but inflation shrinks what it can buy year after year. That loss is real; it is just quiet.
Questions people ask
What is an example of loss aversion?
Turning down a coin flip that pays $110 on heads and costs $100 on tails, though it is favorable on average; or holding a falling stock because selling would “lock in” the loss.
Who discovered loss aversion?
The psychologists Daniel Kahneman and Amos Tversky, in their 1979 paper on prospect theory. Kahneman won the 2002 Nobel prize in economics; Tversky had died in 1996.
How much more do losses hurt than gains?
Studies usually find about twice as much: in Tversky and Kahneman’s 1992 estimate, a loss weighed about 2.25 times as much as an equal gain. Estimates vary between people and situations.
Read more on BigCapital
About the numbers
- The numbers on this page are recalculated from the data every night; the sources are listed at the end of the page.
- S&P Composite price and total return since 1871, and US consumer prices: Robert J. Shiller, Online Data (shillerdata.com); total return with dividends reinvested monthly, calculated by BigCapital.
- Holding periods overlap: one starts in every month since 1926, so the same crash counts in many of them. Prices are monthly averages of daily closes, with dividends reinvested monthly, before inflation.
- This page explains a term. It is not investment advice.