Are We Living in a Loss-Averse World?

(Photo: Blatant World)

Three years ago today, the S&P 500 closed at 676.53.

Today, it opened at 1366.50.

As Businessweek asks: where’s the party for this bull market?

The article, by Whitney Kisling, is interesting throughout, exposing the massive pessimism still attached to the markets despite this steep recovery. It is well worth a read for anyone who believes (or wants to believe) that behavioral economics has a lot to teach us about real-world investing behavior. The money quote:

“What you’re seeing is a gigantic exercise in behavioral finance,” says Brian Barish, president of Cambiar Investors, referring to studies that show investors feel the pain of losses more intensely than the pleasure of gains. “The ability to scare the hell out of people is much greater than the ability to attract them to equities.”

He is talking about what’s known as loss aversion. Believe it.

David S

The S&P 500 is also 200+ points below its all time high.

People en masse won't start to party and buy in until it's a few hundred above that all-time high. Thereby missing the gains, and piling in high, then selling low when we get a correction.

Which is why most people don't end up getting much out of the stock market.


In addition to the (negative) growth of the stock value, you should also have earned significant dividends over that period. I've been investing in an index fund that tracks the S&P 500 since well before its high point. The fund value today is well over the cumulative amount I've invested (which was fairly small sums at approximate monthly intervals). Where else would the excess have come from, if not from those dividends?


Do they not differentiate between a bull market and a recovery?


Perhaps it's because the S&P 500 is still below its 2007 high point. Loss aversion is still part of the psychology. With that being said, the 3-year record is a great illustration of the benefit of dollar-cost-averaging.


2008 was the beginning of a bull market. I guess that's one way to look at it.

James Justice

Loss aversion is interesting to me. It isn't market related, but I play a lot of board games and roleplaying games, and found that when evaluating how well rules will work its something you have to consider.

Games benefit from having the math hidden a bit. If you use a straight roll to complete a task or objective with a 50% chance of success, the player will think that is a fair chance looking at it. And we want games to be fair. But in play it doesn't *feel* fair. The magic rate for my character/piece to feel like I have a fair chance to do something is about 67% as a rule of thumb. If you actually fail as often as you succeed at something that should be an even shot, the game will feel too hard. You need to succeed about 2/3 of the time to get the appropriate feel from the game, IME anyway.

So games work better if you hide the math a little from the player. If you use ten sided dice to generate a random number from 1-100, the game will feel much harder than if you're using something more convoluted.



Are there still serious people who don't "believe" in behavioral economics?

Also, isn't all this talk about "well it's still not at an all time high point" just an example/extension of the sunk cost fallacy?


A funny thing happened while they were all patting themselves on the back for not investing their Social Security funds in the 'risky' stock market...


We are seeing a rational response to risk. If we define stock market risk as price volatility, the market looks very risky to me. I'm sure there are individual stock issues that have relatively stable prices, but many people are investing in the whole market through indexing. If a Greek debt negotiator clears his throat, the market falls wildly. If an unemployment report comes out slightly better than expected, hold on, here comes a rally. We are dealing with a panicky market. The 800 lb gorilla in the room, it seems to me, is a government that is not willing to do what it takes to get our fiscal house in order which puts us at risk of INFLATION...NO MAYBE DEFLATION...nobody can say with certainty at this point. I just looked at my 401k statement. After 19 years of investment every month it adds up to about the sum of what I have deposited. My story could be unique, but I doubt it. I would have been much better off in money markets or AAA bonds. Well at least I am back to even. Should I hold on for another unprofitable ride.