Definition
The disposition effect combines loss aversion with mental accounting: investors feel compelled to realize gains (positive emotional closure) and avoid realizing losses (denying failure). This behavior is tax-inefficient (accelerates capital gains, delays losses) and reduces returns by cutting winners short while allowing losers to compound. It affects both retail and professional investors.
lightbulb Example
Analysis of 10,000 brokerage accounts shows investors sell winners at a 50% higher rate than losers. A stock up 20% gets sold for a "nice profit" while a stock down 30% is held because "it'll come back."
verified_user Key Points
- Sell winners too early, hold losers too long
- Combines loss aversion and mental accounting
- Tax-inefficient behavior (realizes gains, delays losses)
- Affects retail and professional investors alike