When fear is the key

There is the fear of missing out (FOMO) and then, the fear of losses (FOL). Both have opposite effect on an individual’s investment decision. FOMO drives individuals to take high risk whereas FOL makes them give-up gainful opportunities. Here, we discuss why FOL dominates FOMO.

Loss aversion

What if we take losses on investments and then prices go up? Also, taking losses confirms our initial decision to invest was not right.

That leads to regret. The emotional part of the brain is tuned to avoiding regret. Not taking losses can moderate this regret. A factor that plays a dominant role in this behaviour is the time horizon of your investments.

Not a virtue

Patience is not a virtue for most individuals. Yet, most invest for the “long term”. Why? Suppose an individual decides to trade for the short term. That means the individual must take one of three actions. One, take profits if the investment meets the price target. Two, cut losses if the investment hits the stop loss.

And three, close the position if reasonable time has elapsed since initiating the trade without the investment hitting the price target or the stop loss. Now, action two and three triggers loss aversion — that losses loom larger than gains of the same magnitude.

The advantage of considering investments to be long term is that an individual does not have to be concerned about unrealised losses, even if they are large.

The argument is not that long-term is irrelevant or bad for your financial well-being. Rather, whether an individual embraces the “long term” argument to avoid short-term regret. One way to observe if you are suffering from such behaviour is to see if you take quick profits when “long term” investments soar unexpectedly in the short term. Many buy with a long-term perspective yet sell in the short-term when gains are tempting.

Conclusion

Have you avoided short-term investments and missed out the recent rally in gold prices or in the stock market because of FOL? If so, you let FOL dominate FOMO.

You may argue that you invest for the long term. While your life goals and related investments are long term, they are also bound by time.

Do you extend investment horizon to avoid short-term regret? Do you consider a company blue-chip or fundamentally-sound after its stock price falls sharply? Maybe, it is time you look at your narratives with an open mind.

(The author offers training programs for individuals to manage their personal investments)