At Prospera, we believe that financial planning is as much about human behavior as it is about markets. One of the most powerful, and costly, psychological biases affecting investors is loss aversion: the tendency to feel losses more intensely than gains of the same size.



This simple truth helps explain why investors panic in downturns, hold on to losing stocks for too long, or underinvest in opportunities that could build long-term prosperity.

What the Research Shows

The concept of loss aversion was first formalized by psychologists Daniel Kahneman and Amos Tversky in their groundbreaking work on prospect theory. Their experiments revealed that most people need a potential gain of about twice the size of a potential loss before they will take a gamble. In mathematical terms, the “loss aversion coefficient” is around 2.25: losses loom more than twice as large as gains.

Other research built on these insights:

• Disposition effect (Shefrin & Statman, Odean): Investors tend to sell winning positions too soon, locking in small gains, and hold on to losers too long, hoping to avoid the pain of realizing a loss.
  
  
• Myopic loss aversion (Benartzi & Thaler): Investors who monitor their portfolios too frequently see more short-term losses, and become more risk-averse than is rational for their long-term goals.
  
  

These biases aren’t just theoretical, they show up in real portfolios every day.

How It Shows Up in Real Life

Loss aversion can distort investment decisions in predictable ways:

• Bailing at the bottom: In a market selloff, fear of further losses pushes investors to sell at the worst possible time, missing out when markets recover.
  
  
• “I’ll sell when I get back to even”: Anchoring on the original purchase price makes investors hold poor investments longer than they should, turning a financial decision into an emotional one.
  
  
• Over-checking accounts: Looking at daily fluctuations magnifies the emotional sting of losses, even if the long-term trajectory is positive.
  
  

Together, these behaviors reduce returns and increase stress, an unfortunate combination.

Why It Happens: A Quick Tour of Prospect Theory

Prospect theory helps explain why even experienced investors fall into these traps. Unlike traditional finance, which assumes people make decisions based on overall wealth, prospect theory shows that we evaluate outcomes relative to a reference point, usually where we started.

Here’s the key:

• For gains, the curve is concave, meaning each extra dollar gained feels a little less exciting than the one before. (Finding your first $100 feels amazing; the next $100 still feels good, but not twice as good.)
  
  
• For losses, the curve is convex, meaning each extra dollar lost hurts, but the sting of the first loss is sharper than the second. (Losing $100 feels awful; losing another $100 still hurts, but not double.)
  
  
• Most importantly, the curve is steeper for losses than for gains. Losing $100 hurts more than gaining $100 feels good.
  
  

This simple shape of human psychology helps explain why investors chase risk to recover losses, yet shy away from opportunities when they’re already ahead.

What You Can Do About It

At Prospera, we help clients counter loss aversion not by asking them to ignore their emotions, but by designing structures and processes that protect them from themselves. A few guardrails:

• Write it down. A formal Investment Policy Statement sets rules for risk, allocation, and rebalancing, so choices are tied to the plan, not emotions.
  
  
• Reframe the reference point. Look at performance at the household and long-term level, not position by position.
  
  
• Automate discipline. Scheduled rebalancing ensures that you systematically buy low and sell high. At Prospera, we also use systematic models that remove the need to trade based on subjective factors or emotions. This guarantees that decisions are made consistently, separating the emotional impulse from the systematic process, and ensuring that discipline wins over fear or greed.
  
  
• Use a bucket framework. Our Plan Your Tranquility™ approach separates safe assets for near-term needs from long-term growth capital, reducing the urge to panic during downturns.
  
  
• Reduce the noise. Fewer portfolio check-ins mean fewer emotional triggers, helping you stick with the strategy.
  
  
• Harvest losses strategically. Tax-loss harvesting turns temporary losses into potential tax benefits, turning a bias into a tool.

The Bottom Line

Loss aversion is deeply human, and it won’t disappear. But it can be managed. The key is not willpower, but structure: building a plan that anticipates how you’ll feel in both good times and bad, and setting up rules and systems that keep you disciplined.

At Prospera, our mission is to give clients confidence through every stage of their financial journey. Plan Your Tranquility™ means structuring both portfolios and decision-making processes so that short-term emotions don’t derail long-term prosperity.

Have questions about your plan or how this may affect your portfolio? Talk to Prospera. We’re here to help you stay grounded, informed, and focused on what matters.  www.prospera.investments 

This communication is provided for informational purposes only and does not constitute investment advice, a recommendation, or an offer to buy or sell any security. Investors should consult their financial advisor to assess whether any investment is appropriate for their individual circumstances.