Fear of loss, sometimes referred to as loss aversion, is a concept developed as part of Prospect Theory¹ by psychologists Daniel Kahneman and Amos Tversky. Their research demonstrated that people feel the pain of losses far more intensely than the satisfaction of equivalent gains. In practical terms, losing $10,000 tends to feel significantly worse than the pleasure derived from gaining the same amount.

This emotional imbalance can have serious consequences for investors, particularly during periods of market volatility. When markets decline sharply, fear often takes control. Investors may feel an urgent need to act, leading them to sell investments in an attempt to “stop the bleeding.” While this decision can provide short-term emotional relief, it often comes at a long-term cost. Selling during downturns locks in losses and removes the opportunity to benefit from future recoveries.

Market history tends to show that some of the strongest gains occur shortly after significant declines. Take for instance the decline that was seen after the beginning of the current conflict with Iran. At the onset, the S&P 500 began a significant pullback that resulted in roughly an 8.17% decline. This pullback quickly turned into a rebound in which the S&P pushed record highs with a 13% rise off the lows experienced in March. These rebounds can be swift and difficult to time, meaning that investors who exit the market during periods of stress frequently miss out on the recovery.

Having a diversified portfolio can often minimize the effects of loss aversion by creating a smoother ride towards long-term goals.