Why Losses Hurt Twice as Much as Gains Feel Good?

Why do losses feel twice as painful as gains feel good? In this episode, Mary MacNamara and James Yendrey unpack the psychology of loss aversion—and how it may drive panic selling, and missed recoveries.

Summary

The following is a summary of a live audio recording and may contain errors in spelling or grammar. Although IBKR has edited for clarity no material changes have been made.

Mary MacNamara  

Hello everybody, and welcome to the Cents of Security podcast. Today we welcome back James Yendrey of InvestMentor^SM to discuss why losses hurt twice as much as gains feel good. So, imagine this, back in March 2020 as markets plunged, an investor watched his portfolio drop fast day after day. Headlines were nonstop and he checked his phone constantly.

Sounds familiar, right? So, after a 30% decline, he sold everything to just make the pain stop. Weeks later, the market rebounded sharply, but he stayed in cash waiting for clarity that never came. He missed one of the fastest recoveries in history. A month later, the market was higher. So often people say the pain of the drop made the recovery impossible to trust.  So, on that note, James, how are you?

James Yendrey  

I’m doing good. I think that’s a very good segue into this discussion.

Mary MacNamara  

Awesome. I’m so glad you like it. I made it just for you. So why does losing money feel way worse than making money feels good?

James Yendrey  

One feels like a win, whereas the other one kind of feels like a mistake. Making money for everybody is, it’s nice, but losing money, it’s– you’re just scratching your head thinking, “Why did I do that?” and then you tend to remember your losses deeper than your wins. You replay them in your head trying to psychologically think, could you have done something different?

But with wins, you move on pretty fast. You’re like, “Okay, cool. I got it. Carry on. Let’s move on to the next one.” But the losses, they sting a bit more.

Mary MacNamara  

Yeah, I agree with that. So, is this just emotion or is it hardwired into how we think?

James Yendrey  

So, it’s baked in. Your brain is wired to avoid pain. It’s more so than the chase, really. So, when you lose money, your brain treats it like there is something that needs to be fixed immediately. You feel it disproportionately more than you do on that gain. And humans being the perfectly imperfect creatures we are very susceptible to more emotions, especially when it’s driven to things tied to a monetary value as opposed to slight wins in the marketplace.

Mary MacNamara  

Yeah, I think it’s like in the back of your mind. You have that caveman mentality, which is like, “Oh, what’s around the corner? Is it a lion? Like what– Is it– am I going to be attacked? What’s this cascade of waterfalls of problems happening?” I think that comes back to it, and you have to just say, “No, that’s not the case here.”

So, in this case, let’s define loss aversion, and why do losses hit approximately two times harder than gains?

James Yendrey  

They don’t feel good. They hit a lot harder. Usually, when you’re making these types of decisions, especially when it’s directly correlated to money people like to go through the path of least resistance. And so, if it means to cut losses, say at a 10%, when the market can contract, 15% to 20%, as long as you’re holding, you’re not over-leveraged, you’re perfectly fine.

But the thing is, if you’re getting the red notifications on your trading applications, you start seeing these numbers you feel that more intensely, and it’s not a good feeling. And so, you have people shorting really good positions that they got into, short-changing themselves, taking whatever loss that they can to recover minuscule gains or just outright taking the loss before it contracts further down.

Mary MacNamara  

So why do small losses quickly turn into panic selling?

James Yendrey  

That’s a good one. You tend to hesitate after a drop. You second guess good positions where you start thinking back to it as “Did I do my technical analysis right? Were the fundamentals on this particular choice accurate?” When you start second guessing these good positions, you start to hold on to the bad ones because you don’t want to take that loss.

It’s not logical by any stretch of the matter, but it is avoiding the bad feeling of pain.

Mary MacNamara  

How do volatility and real-time tracking, the apps we have, the alerts, make it worse?

James Yendrey  

You can see it. You can see it really happen in real time. You’re getting the notifications, you’re seeing the red and it’s… It sucks, quite honestly. It sucks, especially when you’re looking at it and your alarms are going off or your, your stop losses have been hit, or your take profits have been hit.

It’s better to take a more zoomed out approach to everything. Yes, even in your initial example, you had a huge contraction within the marketplace. But holistically, if you zoom out on that chart, it’s a significant contraction, but it’s nothing that an unlevered an investor couldn’t necessarily weather.

Like you said, 30 to 45 days there later, they were back in the green. And so, taking the downtick, and in my opinion, as the market continues to contract, these present you with more buying opportunities. However, if you’re over-levered and you don’t necessarily have liquidity to actually purchase in it, and you’re, over-levered to the gills, it’s…

You’re really going to feel those pains, and your alarm systems are going to go off, your take profits or your stop losses are going to be triggered. And you’re just going to be eating loss after loss. And in these cases, zooming out and taking a more passive approach in times of volatility as opposed to a more active approach.

Yes, you can squeeze alpha out of pretty much any circumstance that you would like, right? But the fact of the matter is, if you’re wanting to be more of a long-term dominant player in the market think about being an infinite player rather than a finite player, and think long term rather than short term.

Mary MacNamara  

So, going back to the story I told, why do people sell at the bottom and lock in losses?

James Yendrey  

Panic selling it really snowballs. Again, red and it annoys you. The drops tend to make you feel uncomfortable. Think like you’re on a rollercoaster and you hit that dip. Some people seek that chase and you’re like, “Oh my God, this is really cool.” But at the same time other people are throwing up right next to you.

Like it’s not good. And you also don’t know where the bottom is. Hindsight 20/20, right? You don’t know where that bottom is. Are you going to keep bleeding out? Are you going to assume worst case scenarios in every situation? Sure, you should have them mapped out, but I think Warren Buffett said it best is like, “If you bank on the end of the world, you’re only going to get it right once.”

Mary MacNamara  

Ooh, good quote. I like that!

James Yendrey  

Whatever portfolio you decide to build may weather the storm. And ensure that you do your due diligence to figure out if you’re over-levered in a particular one, you can do backtesting and benchmarking to ensure that the overall impact of the portfolio can withstand things like the dot-com bubble, can withstand subprime or now we have data for a global pandemic, and then at least five years’ worth of accurate data on what happens on the recovery from a global shock like that.

So, you’re able to benchmark and backtest a little bit more accurately. And if you do that, you take more of a long-term view on things. You’re going to be more excited for the dips psychologically, right? You’re going to see red, but now red is you’re going to flip that switch.

“Oh, this is a buying opportunity because I’m, 10, 15% cash, so now I’m able to buy in these more opportune marketplaces,” and it goes a lot further.

Mary MacNamara  

Why do we hold losers too long but sell winners too early?

James Yendrey  

So why hold losers but sell winners early? It’s because selling a winner, it feels good.

It’s like, “Nice, I was right. I got the pick. I was able to; I was able to get it.” But selling a loser feels like you’re admitting you messed up, and people don’t like to necessarily admit that they messed up, especially when it’s on your trade log, when it’s on your books and you have to carry that loss.

The end result, you end up you cash out your good ideas, and you keep your bad ones, and it’s not necessarily a sustainable practice.

Mary MacNamara  

So how do you tell the difference between a temporary dip and a real problem?

James Yendrey  

The fundamentals, I would say. Was the price change or the did the underpinnings of that business change? Did it go like Allbirds? So, you’re investing in an apparel company, next thing you know, in their earnings call they shift everything into AI. That is a radical shift, and the market deemed it as a net positive.

Okay. If it were the other way around, it would’ve been a huge net loss for these guys, but if nothing about the company actually got worse, it’s probably just noise. If something did change, then yeah, pay attention. Pay a little bit more attention to the fundamentals of the company and the investments that you actually place.

Mary MacNamara  

So, in your experience, what simple habits or tips reduce panic?

James Yendrey  

Zooming out, we touched on that. Stop looking at daily moves. If you’re an investor and you’re a genuine investor as opposed to a trader in my opinion, take out the daily minutiae into it if you’re investing for the long term and look at the big picture.

Oftentimes, when you zoom out, the chart looks like the chart. You zoom in, you can find ebbs and flows in anything, and everything looks like it’s falling off the cliff, but a 5% contraction in Nvidia will bring down the market. But if you zoom out a little bit, you see it’s over 4,000% over the last 10 years.

5% contraction seems okay, relatively speaking. Check a little bit less. The more you look, the more you react. You start seeing these red flashes coming up, you feel like you need to act when it’s not necessarily the case. Sometimes the best course of action is to rely on the trading strategy, the investing principles that you put.

Go back to the fundamentals. If nothing has changed in the underpinnings, it’s just chop, it’s just volatility, take it as a, an opportunity to increase your position in those particular equities as opposed to selling out. And then I think lastly, it’s really good to benchmark and backtest. Have a plan for when things get messy because in a moment you won’t trust yourself anyway.

Like when you’re in that moment of making that decision, you’re, “Am I panic selling or is this something else?” Either way, emotionally speaking, you are becoming decoupled from your primary objective

Mary MacNamara  

Yes. So, I think that’s a good place to stop. Don’t forget to breathe in those scenarios. And I think, like in all things when you take a step back, it could be trading, it could be something in life, and y- a month goes by, two months go by, and you go, I had that experience, but I’m still here. I’m breathing. I’m okay. The world didn’t end. Everything’s all right.” And so, I think that’s always good to keep in mind in these types of scenarios and also just in life itself. Anyway, James Yendrey of InvestMentor, thank you so much for your insights. We appreciate it and thank you so much for joining our podcast today.

And thank you, listeners.

James Yendrey  

Thank you, Mary. Bye