This is called loss aversion or Prospect Theory (psychologist Dr. Daniel Kahneman won a Nobel Memorial Prize in Economics for his work on this subject). The theory boils down to a single basic concept:
The perceived pain derived from a loss, hurts significantly more than the perceived pleasure derived from an equivalent gain.
So putting it in relevant context, earning $1000 doesn’t create nearly as much joy as the pain created by losing $1000. For most, this emotion is just natural human nature and interestingly enough is even evident in other species.
It’s ironic but because of this emotional imbalance, investors are more inclined to avoid risk in a “gain scenario”, while in a “loss scenario” we are more inclined to seek it out. This amplified pain as a result of losing money significantly influences investors and INHIBITS the ability to make reasonable investment decisions or commit to investment plans. This is perhaps one of the most important factors to understand when designing an investment strategy for investors.
