The Impact and Management of Investment Losses

The growing wealth disparity between the top 1% of America and the bottom 70%-80% is partly due to the lack of investment by the bottom half of the country in with the financial markets. The way to get out of poverty is to have income, but the way to achieve financial stability is to build wealth and plan long term. The problem however is that those who experience poverty or who are part of the bottom half of the country, have much more to lose, therefore are averse to investing. For example, the $600 stimulus check for someone who is just above the poverty line means that they will be able to pay the month’s rent or that their family does not have to starve. Any additional money generally goes to basic life necessities rather than investments. There is also the case of the lack of knowledge regarding the markets and market strategies, and the tendency to exit the market when loss occurs. Additionally, success in the stock market comes with experience, the good and the bad. However, those that cannot take such chances are not going to be able to run through experience and never get to truly succeed in the market. Furthermore, investors of all socioeconomic classes tend to feel pressured by the lack of time and the abundance of information when making transactions. This just adds another layer to the difficulty of participating in the market. I hypothesize that: investors react differently based on how they are informed of their losses, loss aversion causes investors to leave the market and forgo gains, and time pressure causes investors to make less than optimal choices. To test my hypotheses, I interviewed three experienced investors as well as three financial advisors to talk about their experiences with the stock market and the strategies they employ to deal with the changes in the stock market. Regarding hypothesis 1, I found that the way investment losses are phrased does affect individual investors. The investors stated that they try not to look at the absolute dollar amount of their loss at all, and that they look at percentages so they can make rational decisions. The financial advisors said that they only communicate their clients’ losses to them in terms of percentages. They state that it is the best way to keep their clients calm and help them make rational decisions to move forward or to mitigate the losses. Regarding hypothesis 2, I found that inexperienced investors will leave the market when they face loss. The financial advisors stated that they all had clients that left the market following the market crash in March 2020. Even when staying in the market meant gains in the long run, many investors chose to leave because of short term losses. Regarding hypothesis 3, I found that both the financial advisors and the investors admit that when they first started out, time pressure was a major reason for their mistakes. But they also said that making transactions under time pressure does get easier as one becomes more experienced.