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Becoming Averse to Loss Aversion
For most of us, when markets go down, anxiety goes up.
And since markets haven’t gone down substantially for some time, it’s possible that angst is waiting in the wings for a lot of us and could be set loose by the next downturn.
I am not anticipating an imminent demise of the bull run in stocks. But after two great years of returns, it’s important to remember that corrections are normal occurrences.
On average, we can expect stocks to drop 14% from recent peaks in any given year, according to research from JP Morgan Asset Management (recoveries typically follow closely on the heels of these declines).
And it’s important to remember that we as humans are hard wired to disproportionately fear financial losses relative to appreciating similarly sized gains.
We obviously can’t control what happens in the financial markets. But we can control how we respond to financial market developments.
The goal of this article is to provide more information about the concept of loss aversion; explain how it affects investors; and share strategies to overcome it.
Learning to become averse to loss aversion is a strategy that should yield positive results over the long term for your portfolio.
What is Loss Aversion?
Loss aversion is a key principle in behavioral finance introduced by Daniel Kahneman and Amos Tversky in Prospect Theory. Our friends at research outfit DataTrek have this to say about Loss Aversion:
- Classical economics has it that the gain or loss of $1 has the same “utility”, both on the upside and downside.
- Daniel Kahneman and Amos Tversky proved this was not the case with their work on Prospect Theory, published in 1979, with Kahneman winning the Nobel Prize in 2002.
- The possibility (or “prospect”) of losing a particular amount of money weighs about twice as heavily on the human psyche as the prospect of gaining that same amount of money is welcoming.
- Simply put, we are hard coded to be risk-averse, which is probably biologically optimal but not when it comes to investing.
This asymmetry – that people experience the pain of losses about twice as intensely as they experience the pleasure of equivalent gains – can lead investors to behave irrationally, often making suboptimal decisions due to an emotional response rather than a rational evaluation of risk and return.
How Loss Aversion Affects Investors
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Excessive Conservatism: Investors may hold too much cash or invest heavily in low-risk assets, such as bonds, due to an outsized fear of losses. This risk aversion can cause them to miss out on long-term market growth.
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Holding onto Losing Investments Too Long: Investors often refuse to sell losing stocks because doing so would "lock in" a loss. This can lead to further declines in portfolio value if the asset continues to underperform.
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Selling Winners Too Soon: The fear of losing unrealized gains can prompt investors to sell winning stocks too early, limiting their upside potential while holding onto losing positions in the hope of a rebound.
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Panic Selling in Downturns: During market downturns, loss-averse investors may sell off assets at a loss to avoid further perceived pain. This often results in missing out on the subsequent recovery.
Strategies to Overcome Loss Aversion
Investors can take several steps to mitigate the negative effects of loss aversion.
1 - Maintain a Long-Term Perspective
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Historical Context: Market downturns are normal and historically temporary. The S&P 500, for instance, has endured numerous recessions, bear markets, and crashes but has always recovered over time.
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Review Past Recoveries: Looking at previous downturns (e.g., 2008 financial crisis, 2020 COVID-19 crash) can provide reassurance that patient investors tend to be rewarded.
2 - Avoid Emotional Decision-Making
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Recognize Emotional Triggers: Fear and anxiety can drive investors to sell at the worst possible time. Understanding that these emotions are natural but not always rational can help maintain discipline.
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Pause Before Making Major Moves: Implement a 24- or 48-hour rule before making significant financial decisions to avoid impulsive reactions.
3 - Stick to a Predefined Investment Plan
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Set Portfolio Rules in Advance: Establish clear rules for buying, selling, and rebalancing to avoid making decisions based on market noise.
4 - Use Mental Accounting to Categorize Risk
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Investors can separate their portfolios into different “buckets,” such as:
- A short-term stability bucket (cash, bonds) for near-term needs.
- A growth bucket (stocks, real estate) for long-term wealth building.
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This mental separation reduces the fear of short-term losses affecting immediate financial security.
5 - Rebalance Rather Than Panic-Sell
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Automatic Rebalancing: If stock prices fall, rebalancing forces investors to sell overperforming assets (like bonds) and buy underperforming assets (stocks) at a discount.
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Stay within Target Allocations: Keeping the portfolio’s stock-to-bond ratio aligned with the original strategy ensures disciplined investing.
6 - Use Dollar-Cost Averaging (DCA)
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Invest Regularly Regardless of Market Conditions: Investing a fixed amount regularly reduces the emotional burden of market timing.
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Buy More Shares at Lower Prices: Instead of fearing lower prices, DCA allows investors to accumulate more shares when prices are low, boosting returns when markets recover.
7 - Maintain Cash Reserves
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Emergency Fund: Having 6–12 months of living expenses in cash reduces the need to liquidate investments during downturns.
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Dry Powder Strategy: Investors who keep some cash on hand can take advantage of market downturns by buying assets at depressed prices.
8 - Diversify to Reduce Portfolio Volatility
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Asset Allocation: Spreading investments across stocks, bonds, real estate, and alternative assets helps mitigate losses.
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Low-Correlation Assets: Investments like Treasury Bills and Treasury bonds can provide balance when equities decline.
9 - Avoid Market Timing
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Missing the Best Days Hurts Returns: Data shows that missing just a few of the best market days (which often occur after the worst days) significantly lowers long-term returns.
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Stay Invested: Rather than guessing market bottoms, staying in the market increases the likelihood of benefiting from recovery.
10 - Turn Market Declines into Tax-Saving Opportunities
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Tax-Loss Harvesting: Selling losing investments to offset capital gains taxes can improve after-tax returns.
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Roth Conversions: Converting traditional IRA funds to a Roth IRA during downturns allows investors to pay taxes at lower asset values, leading to greater tax-free growth.
The key to overcoming loss aversion during a market downturn is sticking to a well-thought-out plan, staying diversified, and avoiding knee-jerk reactions.
Implementing these strategies can help you manage their emotions, take advantage of market opportunities, and build long-term wealth.
Medicare Advantage Open Enrollment Period
Our founder Susan Moore contributed the following update for Medicare planning
The Medicare Advantage Open Enrollment Period (MA OEP) is currently underway and runs from January 1 to March 31, 2025.
This is an important time for individuals enrolled in Medicare Advantage plans to review their coverage and make any necessary changes.
What is Different about the 2025 MA OEP?
For the 2025 MA OEP, there are no significant changes to the enrollment process itself. However, it's important to be aware of broader updates affecting Medicare coverage in 2025:
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Changes in Plan Availability: There is a reduction in the number of Medicare Advantage plans available in 2025. Some insurers that previously offered Medicare Advantage have left the market. Additionally, some healthcare providers have stopped accepting certain Medicare Advantage plans, so it's critical to verify that your preferred providers are still in-network.
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Adjustments in Premiums and Benefits: While the average monthly premium for Medicare Advantage plans has decreased to $17.00 in 2025 from $18.23 in 2024, some plans may have adjusted their core benefits or reduced supplemental offerings like gym memberships. It's essential to review any changes to your plan's benefits and costs.
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Introduction of a $2,000 Out-of-Pocket Cap for Part D: Starting in 2025, Medicare Part D plans will implement a $2,000 annual cap on out-of-pocket prescription drug expenses. Once you reach this limit, you won't have to pay additional costs for covered drugs for the remainder of the year.
What You Can Do During MA OEP
During this period, if you are currently enrolled in a Medicare Advantage plan, you have the following options:
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Switch to a different Medicare Advantage Plan: If your current plan no longer meets your needs, you can change to a different Medicare Advantage plan.
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Drop your Medicare Advantage plan and return to Original Medicare: You can disenroll from your Medicare Advantage plan and switch back to Original Medicare (Parts A and B). You can also enroll in a standalone Part D prescription drug plan if needed. Note that in most states when someone switches to Original Medicare from Medicare Advantage, insurers can require medical underwriting in order to purchase a Medigap (Medicare Supplement) policy. This means the insurer can deny Medigap coverage if you have certain health conditions. Four states (CT, MA, ME, and NY) have implemented protections that prohibit underwriting in these situations.
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Adjust Prescription Drug Coverage: If your Medicare Advantage plan includes drug coverage, you can change to another MA plan that better suits your medication needs.
Key Considerations
When evaluating your Medicare Advantage options, here are some factors to consider:
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Provider Network: Ensure your preferred doctors, specialists, and hospitals are included in the network of any plan you are considering.
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Drug Coverage: Check whether your medications are covered and if there are changes to the formulary or pricing.
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Out-of-Pocket Costs: Review premiums, deductibles, and co-pays to understand your total potential expenses.
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Additional Benefits: Some plans offer extra benefits such as vision, dental, hearing, and fitness memberships. Compare these benefits to see if they align with your needs.
Common Questions
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Can I switch plans multiple times during this period? No, you are allowed to make only one change during the MA OEP.
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What if I miss the deadline? After March 31, you generally cannot make changes until the next Annual Enrollment Period (October 15 – December 7), unless you qualify for a Special Enrollment Period due to specific life events.
Next Steps
If you’re considering a change to your Medicare Advantage coverage, we encourage you to act early to avoid delays.
Two important resources for help and more information are the Medicare web site, and a State Health Insurance Assistance Program (SHIP) counselor, available at your local senior center.
Private College Scholarships: The Search Is Worth It
Our colleague and college specialist Donna Cournoyer contributed the following update for college planning
Searching for private college scholarships is not always viewed as an effort with a lot of pay off – no pun intended!
Considering high college costs, complicated preparation and application processes, and jam-packed schedules, many students and parents don’t feel like private scholarship dollars are worth the extra effort and time.
I strongly believe, however, that most college applicants should dedicate some time researching and applying for private scholarships before college, and continue to do so during their college years as well.
There are many private scholarships available, and if you use a targeted approach, it can pay off.
The Search
What types of scholarships are available?
Private scholarships are awarded by many different types of businesses, organizations, schools, and other entities based on a variety of criteria.
These criteria may include academic achievements, artist talent, athletic talent, leadership roles, career aspirations, a written essay, and many more.
When you begin to consider searching and compiling a list of private scholarships you will apply for, think about your personal strengths and interests and abilities and how those have shown through in high school, and focus on these along with your intended area of study if you have chosen a path and a major.
This will help you sort through the many scholarships available, and help you with a targeted approach.
When to Apply
Start doing research in your junior year in high school and make a list with application dates and deadlines to be ready for your senior year.
Senior year- Applications open during a wide time range- anywhere from November to submission deadline of sometime through about April for the following Fall college start.
Once you start your college freshman year, many colleges have internal, non-financial need scholarships available to apply for in your second to fourth year. Some can be major specific, or GPA based, etc.
Be sure to find the office who awards them. Start by asking your financial aid office (if it is not them, they will know where to direct you to). You can also search for private scholarships as well. Do this during your winter break.
Where to Apply
First, check your high school guidance office and your school website- they are likely to have information on many local scholarships.
Use recommended sites for your search, from trusted college advisors, high school guidance staff, etc.
Use ONLY free scholarship search sites. If a fee is requested, move on. Qualified sites do not charge a fee.
Check the websites of the colleges and universities you are applying to- they will likely have scholarships you can apply for as well that are outside of merit scholarships.
BEST SOURCE: Local Scholarships from local businesses and organizations- Inquire at local groups, organizations- social, religious, etc., that you belong to or may know you and your family. There is less competition than online national databases.
Why It’s Worth It
A few $200-$500 scholarships may seem inconsequential when peering up at the high costs of college.
However, there are plenty of opportunities to receive scholarships with higher dollar amounts attached, and they can add up.
If the time researching and applying is targeted and well spent, it may be fruitful in turning up additional significant resources for college, which is beneficial regardless of your financial situation.
Every dollar you receive in scholarships means a lower out-of-pocket cost for college, and therefore a greater opportunity to save and invest or increase spending capacity for other necessary items.
Other Tips for High School Students
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When essays are required, write your own. Do not have a parent or adult write them and do not use AI. It will be noticed and could get you disqualified!
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Write your personal story from the heart. Write about your personal struggles and triumphs, growth and dreams. Let the committees get to know YOU.
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You can build these essays from your college admission essay. Use the work you have already done (hopefully) and create your scholarship essays from the considerable thought you have already given to your admission essay, and tailor for each scholarship application.
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Think of applying for scholarships as a part-time job. Once you receive some awards, think about how many hours you have spent working on applications, and do the math: it is likely a decent return.
This work itself will help prepare you for college, because it helps build skills with regard to time allocation, organization, research, self-reflection, and more.
All the work and preparation done in high school is a resource to help you shine on your scholarship applications.
Good Luck!
Atomic Habits: Tiny Changes, Remarkable Results
James Clear has a seemingly simple life thesis: changes that seem small and unimportant at first will compound into remarkable results if you’re willing to stick with them.
He learned this the hard way, through a slow recovery from a traumatic sports-related accident in high school that ultimately led to success on the college athletic field.
This book resonates with me because Clear takes the idea of compounding, which is simultaneously simple to calculate and remarkable to behold, and applies it to everyday life.
Clear’s extensive research into human behavior helped him identify key components of habit formation and develop a straightforward framework for making change in our lives possible.
He posits that a habit is a behavior that has been repeated enough times to become automatic. The ultimate purpose of good habits, contends Clear, is to solve the problems of life with as little energy as possible.
Clear calls his framework “The Four Laws of Behavioral Change” and presents a simple set of rules we can use to build better habits. They are: (1) make it obvious, (2) make it attractive, (3) make it easy, and (4) make it satisfying.
Since your habits are shaped by the systems in your life, Clear discusses his Four Laws throughout Atomic Habits to demonstrate how to use them to create a system in which good habits emerge naturally.
The author is also a compelling speaker. You can hear James Clear discuss the ideas in this book on The Peter Attia Drive podcast Episode #183.
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