Imagine opening your investment account and seeing that it gained $50,000 over the past few months. It feels good. Now imagine opening the same account and seeing that it lost $50,000. For most of us, those two experiences do not feel equal.
There is a name for this: loss aversion. It is one of the most well-known ideas in behavioral finance because it helps explain something many investors have experienced firsthand. We tend to make very different decisions when we are trying to avoid a loss than when we are pursuing a gain.
There is nothing unusual about wanting to protect money you have worked hard to build. In fact, that instinct can be useful. The challenge comes when the fear of losing more becomes strong enough to change the way we make decisions. At that point, a choice that provides immediate relief can feel like the safest option, even when it may not be the best one for our long-term goals.
Why Losses Stick With Us
Psychologists Daniel Kahneman and Amos Tversky helped introduce the idea of loss aversion through their research on how people make decisions when the outcome is uncertain. Their work found that people generally feel losses more strongly than equivalent gains. A later study estimated that a loss could carry more than twice the emotional weight of a comparable gain, which eventually gave rise to the popular idea that losses hurt twice as much as gains feel good.[1,2]
That ratio should not be taken too literally. More recent research has found that the strength of loss aversion varies considerably depending on the person and the situation.[3] What matters for financial planning is the broader idea: gaining and losing the same amount of money may look identical on a spreadsheet, but they often do not feel identical to the person looking at it.
Consider a portfolio that falls from $2 million to $1.7 million during a difficult stretch in the market. You may understand that markets fluctuate, and you may have lived through downturns before, but seeing $300,000 disappear from your statement can still be unsettling. It is one thing to understand volatility in theory and another to watch a meaningful portion of your savings temporarily decline.
That is often when the way we think about the portfolio starts to change. Instead of asking what gives us the best chance of reaching our long-term goals, the more immediate question becomes how to avoid losing another $300,000. Moving a large portion of the portfolio into cash can suddenly feel appealing. Selling an investment that keeps falling can feel like taking control of the situation. Reducing risk after a difficult year can simply feel responsible.
Sometimes those changes are appropriate, especially if your circumstances or financial needs have changed. Other times, however, we may be trying to solve the discomfort created by the loss rather than a problem with the financial plan itself. That distinction matters because a decision that reduces anxiety today can introduce a different set of risks tomorrow.
Cash is a good example. It can play an important role in a financial plan, particularly for money that may be needed in the near future. But holding too much cash for too long can create other problems, including inflation risk and the possibility that your money does not grow enough to support future spending. Selling investments during a downturn also creates another decision that sounds simple but rarely is: when do you get back in? Markets do not usually wait for the news to improve before they begin recovering.
We saw an unusually clear example of this during the COVID-19 market shock in 2020. Vanguard studied investors who moved completely out of stocks and into cash between February 19 and May 31 of that year. Fewer than 0.5% of the investors in the study made that move, but by the end of May, more than 80% of those who did would have been better off simply remaining invested.[4] That does not mean staying invested is always the right answer, nor does it mean every market decline will recover that quickly. It simply shows how different a decision can look once the fear surrounding it begins to fade.
A Long-Term Plan Can Feel Very Short Term
Loss aversion becomes even more relevant when we consider how often we look at our investments. We may be investing for a goal that is 10, 20, or 30 years away, but technology now gives us the ability to watch the value of that long-term investment change every day.
Researchers Shlomo Benartzi and Richard Thaler explored this idea through something called myopic loss aversion. In simple terms, when people dislike losses and evaluate their investments frequently, they give themselves more opportunities to see those losses and react to them.[5] A retirement account may be designed to fund spending decades from now, but if we check it every morning, we can easily start judging its success based on what happened yesterday.
The market also looks very different depending on the time frame we use to measure it. Over the 98 calendar years through 2025, the S&P 500 produced a positive return in about 74% of years and a negative return in about 26%. When the measurement period is stretched to rolling 10-year periods, about 94% of those periods were positive.[6]
That does not mean stocks are guaranteed to make money over any particular 10-year period, and past performance cannot tell us what the next decade will bring. The numbers are still useful because they show how much our experience of investing can change depending on the window through which we view it. If your retirement is 20 years away but you are evaluating your portfolio every few days, there is a mismatch between the time horizon of the goal and the time horizon of the decision.
That mismatch is one reason normal market volatility can begin to feel like evidence that something has gone wrong, even when the financial plan itself has not materially changed.
A Portfolio Can Be Down Without the Plan Being Broken
When markets fall, one of the first questions we naturally ask is, "How much did I lose?" From a planning perspective, there may be a more useful question: What actually changed?
Did the decline materially affect your ability to retire when you planned? Do you need money from the portfolio soon? Has your spending changed? Has your income changed? Are you taking more investment risk than your financial plan can reasonably support? Those questions put the market decline back into the context of the life the portfolio is supposed to fund.
Sometimes the answers will tell us that a change really is necessary. Someone retiring next month and beginning large portfolio withdrawals may have very different concerns from someone who is still working, saving, and contributing every month. This is why investment risk should never be considered separately from the financial plan.
A portfolio being down and a financial plan being broken are not necessarily the same thing.
Market declines are an unavoidable part of owning investments whose values fluctuate. Charles Schwab reviewed 50 years of S&P 500 history and found that the average largest decline within a calendar year was about 15%.[7] Those declines certainly did not feel average to the people living through them, but they are a useful reminder that a well-built financial plan should expect difficult markets rather than treat every downturn as an unexpected emergency.
The Decisions We Make Along the Way Matter
Morningstar's annual Mind the Gap research provides another useful way to see how investor behavior can affect results. Its 2026 study compared the returns generated by U.S. mutual funds and ETFs with the returns actually experienced by the dollars invested in those funds. Over the 10 years ending December 31, 2025, the average dollar invested earned about 8.7% per year, while the funds themselves generated an aggregate annual return of 9.9%.[8]
That 1.2-percentage-point difference reflects the timing and size of investors' purchases and withdrawals. Morningstar is careful to point out that not all of the gap represents poor decision-making; people move money for plenty of legitimate reasons. What is especially notable is what happened as volatility increased. The least-volatile group of funds had a gap of roughly 0.4 percentage points per year, while the most-volatile group had a gap of more than 2 percentage points.[8]
In other words, the investments that gave people the biggest emotional ride were also the ones where the timing of investor decisions tended to have the greatest effect on their experience. That does not mean volatility should always be avoided. It means the amount of risk in a portfolio has to make sense not only on paper, but for the person who has to live with it when markets become uncomfortable.
Build the Plan Before You Need It
Loss aversion is not something we need to eliminate. If your portfolio falls sharply, it is perfectly reasonable to feel uncomfortable. That money may represent retirement, college tuition, financial independence, or decades of work and saving. The goal is not to become emotionless about money. It is to recognize when emotion may be influencing a decision that has long-term consequences.
That is one reason some of the most important investment decisions are best made while markets are calm. How much cash do you need? What money might you need in the next few years? How much volatility can the rest of the portfolio reasonably absorb? What would a 10% or 20% decline mean for your actual financial plan? Thinking through those questions ahead of time gives you something concrete to return to when markets become more difficult.
When that happens, rather than making a change simply because the account balance is uncomfortable to look at, we can go back to the plan and ask whether something meaningful has changed. Sometimes it has, and the strategy should change with it. Other times, the market moved exactly as markets sometimes do while the goals, time horizon, income needs, and long-term plan remain intact.
Being able to tell the difference does not make a market decline feel good. It can, however, help keep a temporary loss from leading to a decision that lasts much longer.
Sources
- Daniel Kahneman and Amos Tversky, 'Prospect Theory: An Analysis of Decision under Risk,' Economica, 1979.
- Amos Tversky and Daniel Kahneman, 'Advances in Prospect Theory: Cumulative Representation of Uncertainty,' Journal of Risk and Uncertainty, 1992.
- Walasek et al., 'A Meta-Analysis of Loss Aversion in Risky Contexts,' Journal of Economic Psychology, 2024.
- Vanguard, 'Cash Panickers: Coronavirus Market Volatility,' July 2020.
- Shlomo Benartzi and Richard H. Thaler, 'Myopic Loss Aversion and the Equity Premium Puzzle,' The Quarterly Journal of Economics, 1995.
- Capital Group, 'Time, Not Timing, Is What Matters,' S&P 500 data through December 31, 2025.
- Charles Schwab, 'The Ups and Downs of Stock Market Volatility,' 2026.
- Morningstar, Mind the Gap 2026, data for the 10 years ended December 31, 2025.