Understanding and overcoming the fear of loss in investing

The goal of financial planners is to help their clients make smart decisions that will benefit their financial future. One common challenge many people face is the fear of losing money, also known as loss aversion. This fear can lead to overly cautious investment choices, like preferring safe but low-growth options (such as bonds and cash) over potentially higher-growth options (like stocks and property). While safer investments provide stability, they often don't keep up with inflation over the long-term, which can cost you in the end.

Why we all do it

Many South African investors tend to avoid high-growth investments despite their better performance over time. For example, the South African Equity General category has delivered the best performance since March 2003 but has seen net outflows. Meanwhile, the South African Multi-asset Income category, which has the lowest growth, has gained R300 billion in net inflows. This behaviour seems irrational and highlights the need for a balanced approach that includes growth assets.

How can a financial planner help you?

1. Recognise the bias

The first step is to understand your own fear of loss. We can do this through simple exercises. For example, if given a choice between a guaranteed gain of R1000 or a 50% chance of gaining R2000, most people choose the guaranteed gain, even though the expected value is the same. Similarly, when faced with a guaranteed loss of R500 versus a 50% chance of losing R1000 or nothing, most people choose the guaranteed loss. These exercises help you understand your risk tolerance and how it affects your investment decisions.

2. Reframe your perspective

It's important to focus on your long-term financial goals rather than short-term market ups and downs. Over a rolling 5-year period, the average high equity balanced fund has not had a single negative return in nearly 25 years. It also has a high success rate of outperforming the multi-asset income category over longer periods. Even though 20 years may seem like a long time, it's a realistic investment horizon for retirement savings. Only investments in stocks can meaningfully beat inflation over this time, which is crucial for growing your wealth and achieving financial freedom.

3. Diversify investments

Diversification means spreading your investments across different types of assets to reduce risk. This approach offers diversification across asset classes and different fund managers to balance growth and stability. 

Conclusion

Overcoming the fear of loss is essential for your long-term financial success. By recognising your bias, focusing on long-term goals, and diversifying your investments, you can build a balanced portfolio that includes growth assets. This approach helps you achieve your financial goals and ensures your investments can outperform inflation, providing real growth in purchasing power.