Loss aversion is the tendency to prefer avoiding losses over acquiring equivalent gains. Investors feel the pain of a loss more acutely than the pleasure of a gain.
Impact
• Holding on to losing investments for too long, hoping to break even.
• Avoiding potentially profitable investments due to fear of loss.
Example
An investor holds a falling stock in her portfolio, unwilling to sell because she does not want to "realize" the loss, even if there are better opportunities elsewhere.
How to Mitigate:
Place stop-loss orders so that selling occurs automatically at a predetermined price.
Judge investments on the basis of their potential future returns, rather than past performance.