Wednesday, February 26, 2020

What's driving your investment strategy? FOMO or loss aversion?


The Dow Jones dropped 1,032 points on Monday and 879 points on Tuesday due to concerns about COVID-19.  It seems logical that a slowdown in activity would negatively impact the global economy.  And since things were already heading downhill last year - GDP growth in 4thQ was 2.1%, before corrections which generally lower it significantly - we are not well poised to withstand a downturn.

So investors have to decide what motivates them more.  FOMO or loss aversion. 

We are hard wired to fear change.  And we hate to lose more than we like to win.  It's called "loss aversion."  In their seminal study on Prospect Theory in 1992, Tversky & Kahneman identified a two to one ratio.  Meaning that we hate to lose twice as much as we like to win. (Tversky & Kahneman, 1992)

On the other hand, we also hate to miss out.  That's why sales of tickets for Broadway shows soar after they announce their pending closure.  So that's where the FOMO comes in.  A move to safer investments could mean losing out if the stock market continues to climb.

So the question is which of these opposing forces will win out.  I'm betting on loss aversion.  How about you?


Tversky, A. & Kahneman, D. (1992) Advances in Prospect Theory: Cumulative Representation of Uncertainty.  Journal of Risk & Uncertainty.  Retrieved February 25, 2020, from

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