While Nobel Prize-winning Economist Daniel Kahneman is not a believer in active management, his research is something investors and advisors should make themselves familiar with, Investment News says in a recent editorial.
“One of Mr. Kahneman’s early findings was that investors’ reactions to gains or losses are not symmetrical,” writes Investment News. “The pain of a loss is far greater than the pleasure they feel from a gain of equal value. Most studies suggest that losses are twice as powerful, psychologically, as gains.”
Because of that, investors have “an exaggerated bias against losses,” a phenomenon known as loss aversion.
Then there is “optimism bias,” another phenomenon Kahneman has studied. It “causes some investors to believe they are less at risk of having negative outcomes than others, that they are less likely to have losses in the market than others,” explains Investment News.
Loss aversion, optimism bias, and other behavioral biases can cause investors to act in ways that severely damage their portfolios. Bottom line: Awareness is power, and reading Kahneman’s work can make you better aware of — and better able to deal with — those biases.