The phenomenon of loss aversion is one of the reasons that your brain can trick you into losing money, explains Gary Belsky, author of Why Smart People Make Big Money Mistakes…and How to Correct Them.
Loss aversion is a term used to describe how people respond more strongly to the loss of a given amount of money than they do to a gain of the same amount.
Consider this: You’re in a convenience store one night. There’s a sign at the counter that reads “3% discount for cash purchases.” You have cash and credit cards with you. Which one do you use?
Most people would use credit cards.
But let’s say, in the same situation, there’s a sign at the counter that reads “3% surcharge for credit card purchases.” You have cash and plastic with you. Which one do you use?
Both questions pose basically the question, but people are more likely to use cash when presented with the word “surcharge.” Their brains interpret this as a loss.
Now, loss aversion is mostly helpful, but it’s also counter-productive. It can lead you to not sell a bad investment, because you keep hoping that the stock will rebound at some point.
A useful trick when thinking about selling or keeping stock is to ask yourself this question: “If I was considering buying stock in this company, would I buy it now?” If the answer is no, then you should sell.