An emotional bias is a change in perception and decision making due to emotional factors like impulse or intuition.
Addressing Emotional Biases:
Emotional biases are driven by fears and/or desires unlike perception biases which are mental "short-cuts" that bypass reasoning. As such, actively working to reduce emotions when it comes to investing can lead to better outcomes.
- What is it? People typically feel the pain of loss more profoundly than the joy of an equivalent gain. Research has found that some investors need to "win" twice as much as they need to "lose" to be indifferent to taking risk
- What are the effects on investors? Loss aversion leads individuals to hold on to losing assets, as they want to avoid the pain of seeing a loss materialized, which only intensifies the losses even more. Similarly, some investors also tend to sell winning assets too early, missing out on further potential gains.
Loss aversion reflects the human tendency to feel the pain of loss twice as much as the pleasure of gains. Imagine you are invited to participate in a coin toss where you would win $100 if it lands on heads and lose $100 if it lands on tails. Would you play? If you're like most people, you'd decline because of the equal chance of losing $100.
According to behavioral economists David Kahneman and Amos Tversky, the win, or gain, that would induce people to play is generally about $200 or 2x1 of their losses.
Our strategies can help you to minimize loss aversion or other emotional biases, for more information click here.