Are you a sore loser?

One of the most famous theories we have from psychology that is closely related to investments is the idea of Prospect Theory founded by Daniel Kahneman and Amos Tversky. Essentially, for every dollar more that we gain, we have less happiness per dollar. Similarly, for every dollar loss, the less painful it become. However, it is also noted that losses weigh larger than gains – a dollar lost is more painful than a dollar gained in terms of their magnitudes. Basically, 赢是应该，输是悲哀 – to win is a little glad, and to lose is very bit of sad.

Common examples of prospect theory include:

1. Feeling less satisfaction if we were to receive $100 only to give away $50 against that of just being awarded with $50

2. Losing $100 is way more painful than gaining $100

In fact, getting insurance plans depict prospect theory to its fullest. You may be paying for a $500 plan to protect yourself from a $100,000 downside with only a 0.01% probability – which nets out to protecting yourself from an expected loss of $100 (technically a gain of $100). This is because despite being rational about the expected values, we just can’t accept such a huge loss if it really did occur.

Now, perhaps some day-to-day examples of what you may encounter that’s slightly more relatable.

Do you have a friend that constantly pays for dining bills first and then splitting later? Do you feel that there have been more occasions that your friend may have rounded up the bills? Suppose that your friend follows the rule of rounding up or down to the nearest whole number so that we won’t be too… “penny-wise”. Let’s say $32.66, split by 2, giving us $16.33 per pax, it would be rounded down to $16.00. Or, alternatively, if it is $33.66, split by 2, giving us $16.83 per pax, it would be rounded up to $17.00. Now, assuming all bills are random which likely is the case, and we will have an equal chance of rounding up or down. However, in our minds, we tend to notice how our friend has rounded up (loss scenario) more than we can remember him rounding down (gain scenario). To make matters worse, we may at times fail to remember the times this friend may have not sought for payment or to casually foot the entire bill.

We, too, anchor too much on the reference point at times. I recently had a small debate with the parent of a tutee of mine. About 3 months ago, I offered an additional 30 minutes of tuition time free-of-charge out of goodwill at the start of our engagement. Just a few days back, the tutee himself requested for a 90-minute session rather than a 120-minute session since he was already mastering the concepts so well and attention drifts away after the 90-minute mark. The parent messaged me indicating the feeling of being “cheated” because of the reduction in tuition time. But ultimately, the main crux was missed out – the quality of the tuition remains the same, and the benefit provided before was out of goodwill and now it is back to the market rate. Essentially, if a swimming coach forces his student to swim 50 laps per session, an improvement in time from 120 minutes to 90 minutes should spark joy in the parent rather than disdain. A side benefit would be the coach leaving for home earlier.

We often focus on our losses and not the gains. In looking at past returns of funds, which option would you choose?

1. Fund A: Made 12% p.a. over 8 years and lost -10% p.a. over the most recent 2 years

2. Fund B: Made 7% p.a. over the last 10 years

Most may think that Fund B is a better choice because of how consistent the gains are, and with only gains being presented. Yet, these two examples are exactly the same that gives you a 2x growth on your portfolio. However, just leaving out the losses can make the decision smoother.

Furthermore, we are bad at estimating risks. In order to recoup our losses and to save us some face, we adopt riskier trades in attempt to cover the paper loss. When focusing on how to overcome our losses, our monkey brains fail to assess the risks accompanied with it. Because of our failure to weigh the risks and often become riskier, we take on poor investment choices. We may end up losing much more. This is tied to the weightage of extreme probabilities i.e. <5% and >95%. We may overweight probabilities that are less than 5% and underweight how likely 95% is to occur. Unrealised losses can be particularly dangerous because we assume we can avoid realising it just by making them disappear from “better” investment choices.

All in all, be mindful that we tend to hyperfocus on our losses at the present moment. There are times we may have realised our gains and kept our losses, and these losses snowball on our brokerage accounts, prompting us that we are deeper in losses. What could help us would be to keep a record of where you are and compare it from where you have first started – perhaps you may see that you may not have lost as much anyway!

If you're interested to chat on this topic or to exchange ideas, please feel free to drop me a message on Telegram @elijah2212 or through email elijah.thj@gmail.com!