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The Theory of Loss Aversion

Profit and loss are the two sides of taking risks. You have to embrace them both while investing.

Last summer I decided to visit a sea beach with my friends. The entire trip was amazing – except for the last dinner night.

I remember ordering a fish fry and tuna salad with some rice. My friends ordered chicken biryani and told me not to have tuna salad. According to them, here tuna fishes are usually rotten and sometimes cooked ignoring the expiry date.

However, as I have already ordered, I decided to cling to my decision.

It was hard for me to accept my fault

When the dish arrived, I noticed with utter disgust that my friends were right, the tuna salad dish was smelling horrible!

And you know what, I still finished the dish – as I didn’t want myself to be proven wrong in front of my friends.

Expectedly, I had to suffer from a long stomach ache after that incident.

In the world of finance, especially in the stock market, often our fear of losing and being proven wrong leads us to disaster.

Last night I had a long argument with my dad regarding his capital market portfolio. He owns some miserable stocks which show no growth prospect any soon.

On the other hand, as the market is going bearish, some value stocks are now trading at a pretty low price which should be purchased in no time.

I tried to pursue my dad saying, ‘Look, if you free up your capital from those shitty stocks and invest in these value stocks, your profit will be skyrocketed within the next three months!’

The fear of risk and irrational exuberance run the share market

First of all, maybe I am wrong, but my academic knowledge tells me that it is the right time to invest in value stocks. As his capital was locked in a diverse portfolio, he was really missing out on the opportunity.

Even I tried to calculate a hypothetical scenario of profit if he sold his certain stocks and brought new ones according to my suggestion.

Unfortunately, he denied my proposal, telling that, ‘You see son, I have invested a handsome amount of money in the stocks that you are forcing me to sell. And I believe, their prices will go up when the market stabilizes again. So it is not the time to offload.’

I was sad, but not surprised. It is our nature to cling to the decisions that we have taken in our lives. We better chose to live in a fantasy that supports our decisions than facing the reality that denies them.

The human brain wants to narrate reality as it rationalizes its decisions

And this phenomenon is not limited to the field of finance. Our entire society and civilization are run to justify our deeds.

The USA sends more soldiers to Iraq to prove that the Bagdad attack was a rightful act from the states.

Religious fanatics keep preaching their radical ideologies to which they have devoted their entire lives.

If you leave your tenet, you have to start anew. And all of a sudden, your whole life becomes a lie.

Very few people have the stomach to do so!

Just because I made a mistake, I will not cling to it!

Very few of us have the guts to embrace our faults and start a fresh journey

Here you may like my other article on risk-free profit-making, I shall start writing a finance series on this topic.

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Location: Dhaka, Bangladesh

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