Why We Prefer Inaction and Loss Aversion to Action and Gains

Below is a link to an interesting article that helps to explain why people had trouble acting on the obvious opportunity that last March's low equity prices presented investors.

The article says that golfers make fewer birdie putts than par putts (adjustments are made for distance and other factors) and at the professional level cost themselves millions in winnings. Apparently, the fear of a bogey is greater than the desire to get a birdie. So, even though both putts mean the same to the golfer's score, they embarrassment of the bogey (loss) is much more motivating than the pleasure of the birdie. (gain)

The authors also cite a study of blackjack players which documents that the greatest cause of sub-optimal play is not taking additional cards that you should. In other words, doing nothing in order to avoid loss was preferred to taking additional cards to win the hand.

I personally met with dozens of investors during the March period who, while aware of the opportunity in the market and for the need for change in their own portfolio, could not "pull the trigger". In their minds, no matter the state of their own portfolio, doing nothing was the preferred course of action.

I took it personally at the time that these folks couldn't move forward with my recommendations. Now that I've read this article though, I realize it had more to do with human nature than my communications skills.

-Christopher

Investing Lessons from Golf and Blackjack Players

By Robert Huebscher

The Lehman bankruptcy, which occurred a year ago today, was the nadir of a financial crisis brought on by excessive risk-taking throughout the investment industry.  Naturally, reigning in risky behavior has been in vogue since, and regulators are hard at work trying to do just that wherever possible. Sometimes, however, the problem is not too much risk, but too little. Indeed, research confirms that individuals are hard-wired to avoid certain risks at crucial times—even when, in so doing, they impose costly economic penalties on themselves.

Read the full Advisor Perspectives article "Investing Lessons from Golf and Blackjack Players" »