Definition
Discovered by Kahneman and Tversky (Nobel Prize 2002), loss aversion is the most fundamental behavioral bias in finance. A $1,000 loss causes roughly twice the emotional impact of a $1,000 gain. This asymmetry leads to suboptimal behaviors: holding losing positions too long (hoping to break even), selling winners too early (locking in gains), and excessive risk aversion that reduces long-term returns.
lightbulb Example
An investor holds a stock down 30%, refusing to sell despite deteriorating fundamentals, because realizing the loss is psychologically painful. Meanwhile, they sell a stock up 20% to "lock in gains," missing further appreciation. Both decisions are driven by loss aversion.
verified_user Key Points
- Losses feel ~2x more painful than equivalent gains feel good
- Leads to holding losers and selling winners prematurely
- Foundation of prospect theory
- Most fundamental behavioral bias in investing