If you want to accumulate wealth, it’s vital to overcome the fear of potentially losing money
How to overcome the fear of losing money
In a recent survey we conducted, we found that the fear of losing money was a significant factor in why people don’t feel confident investing. Unfortunately, in this ultra-low interest rate environment, keeping cash in a high street savings account means losing money to inflation over the longer term. Equally, research shows that the best way to accumulate wealth is by investing in the stock market.
Suffering from loss aversion
Simply put, loss aversion is how much you prefer to avoid losing money over gaining the same amount of money. This means placing greater weight on concern for losses than on the pleasure from gains, even when the amount of gain and loss is equal. A simple example would be the feeling that it’s better not to lose £10 than to find £10.
So how risk-averse are you?
Here’s a quick test. You’re offered a choice of two deals where you can spend £2:
- You invest £2 in the morning knowing that by the evening you have: a 10% chance of losing 80p; a 30% chance of losing 40p; or a 60% chance of gaining 70p.
- You buy a National Lottery ticket for £2 in the morning, knowing a jackpot of £5million is being announced in the evening.
Logically, the first outcome is your greatest chance of making money, with a nearly 2 in 3 chance of making a gain. By contrast, the second deal is almost certain to lose you money; in real terms, the odds of winning the National Lottery jackpot are 1 in 45,057,474.
And yet, studies have shown that most people are happy to participate in the second deal, full in the knowledge that they will likely lose their money. The reason for this is simple: for people to be willing to put their money down, they need the opportunity of instant, exponential returns. However, this is more than likely to hurt them in the long-term. That’s why it’s so important to tackle loss aversion.
Conquering the fear
There are lots of ways to improve your investing confidence, but some good places to start are:
- Build up your knowledge. There’s no need to be an expert in economics, but a general knowledge of what’s going on in the world, and in the stock market, will help you feel much more comfortable when making decisions. Understanding how financial markets operate, or how policy announcements and interest rate changes can affect stock prices, can give you a greater insight into whether to buy or sell. We have a set of useful guides that can give you an idea of where to start
- Rationalise your decisions. Our decisions are rarely as balanced when we’re ruled by emotion, whether we’re buying out of irrational excitement or selling out of fear of falling values. Just like in the example we used above, choosing the modest first deal is far more likely to yield a return than the second. Keeping a cool head can help investors make reasonable decisions.
- Set realistic goals. Be clear where you want to be financially and the time frame to achieve it. If you seek greater return, you may have to wait longer. If you say that you want to reach £1million in personal net worth by the age of 50, you aren’t going to get there by putting aside £2000 a year between the age of 30 and 50 at a historically probable rate of return. This means you need to either lower your expectations or increase the amount of money you are putting to work each year.
- Diversify your portfolio. Never invest all your money in one place. Instead spread it over a basket of stocks and bonds, even across different regions. This reduces the risk of loss or severity of loss as, when one stock suffers a loss, another one can make a gain.
Investing for the first time
Sometimes the only way to get started is to learn by doing. It’s always advisable to begin with small sums of money so you don’t risk too much whilst you’re still learning. Once you start to feel confident, you can think about investing regularly with larger amounts.
If you want to get involved in investing but you’re not sure where to start, Ready-Made investments can be a good introduction. Your money is invested by expert fund managers for you, with each fund containing a combination of cash, shares and bonds. You simply make a choice as to how much risk you’re willing to accept, and the investments are made on your behalf. It’s a great way to invest without the hassle of choosing your own stocks and shares.
As ever, the basic rules apply: don’t put all your money in one basket, never invest more than you have to lose and, if in doubt, be sure to seek independent financial advice. Happy investing!
All information given including prices, yields and our opinion is correct at the time of publication. Our opinions on investments can change at any time and for our latest view please go to www.share.com. To understand how our Investment research team arrive at their views please read our Investment Research Policy.
Open a Ready-made ISA to start investing