One of the challenges in investing in Equity Mutual Funds is that the negatives impact us far more than the positives.
If you had invested Rs 1 Lakh in equity markets a year ago and it is now worth about 1.25 Lakhs; while the profit of 25K makes you feel justified in making the investment, I don’t think the profit of 25K gives you great joy. On the contrary, if you had invested the same Rs 1 Lakh on 29th Jan and today that portfolio is showing a balance of Rs 0.90 Lakh as on date, i.e. a loss of Rs 0.10 Lakh on your investment. Granted that the investment was meant for a long term say 3-5 years, you would still feel extreme pain.
This concept was coined by legendary psychologists Amos Tversky and Daniel Kahneman way back in the early 90s, stating loss aversion alludes to the fact that “The pain of loss is far greater than the joy of gain”.
Loss aversion is a psychological state common to all investors and therefore leads to some strange behavioral changes
In spite of having a long term outlook they may choose to exit their investments at the first sign of loss because the pain of loss is too much to bear. Leading to inefficient investment experience.
Staying invested in inefficient investments which yield lesser returns as they wish to avoid pain from potential losses that could arise on account of the change. Sticking to the ‘STATUS QUO’
In order to compensate for the possibility of a loss in the Equity Mutual Fund portfolio, the investor takes extreme risks in investing in High Risk Sector funds to get a unreasonably high short term gain, which are akin to do or die options rather than wait for a long term more stable diversified funds.
If you can’t sit calmly even when you equity portfolio is down 30 % due to market mechanics, then Equity investing is not for you. Take a long term view, review your portfolio and ensure that your investments are good ones… and then SIT TIGHT.
So while investing into Equity Mutual Funds, guard yourself against LOSS AVERSION, if you want your investment experience to be a PROFITABLE ONE.