High Five for Love!

Often the quote, “Better to have loved and lost than never to have loved at all” is used around this time of year, but is the same true for investments? Is it better to have invested and lost than to never have invested at all?

Clearly, in monetary terms, the answer is simple - no. Underneath this there are some other underlying factors. By having invested any money at all, a person is gaining a new experience that they can learn something from. Now I’m not saying, that this very yoctosecond you go out and invest your life savings, rather people should consider investments as a quintessential part of anyone’s retirement plan.

Too many people don’t understand their opportunity costs, costs of capital, and risk tolerances. People say they are risk-averse, but when the market is booming, they no longer care to hedge and diversify risks. Eventually the bubble pops and there’s a landslide. People may come to see their mistakes, but somehow they forget and the vicious cycle continues. This increases market volatility and should be discouraged.

In Behavioral Finance, Daniel Kahneman and Amos Tversky developed Prospect Theory. One of the key takeaways of this theory is that people get more disutility through losses than utility through gains. This plays a very important role in downside protection of wealth and gives a reason to why value has outperformed growth for extended periods of time.

As seen in the graph, as your losses increase linearly, your gains needed to recover to zero increases exponentially. “Extra needed” shows the difference between “what is needed to make up” and the “loss.” “Marginal increase of need to make up” is the increase of what is needed to make up as losses increase.

This ties in with Prospect theory because people in reality don’t want to lose money, not really because of the snowball effects, but more because they are losing hard-earned money that is hard to get back.

The thing is, hard-earned money, should be used for intensely researched investments. People shouldn’t invest just so that they can “get rich quick,” but rather because they love finance and investments, what it means to learn more about a company, the economy, and human psychology. The returns are a bonus to continue what you are doing. This is why I believe in that passion and prestige in not just Finansophy, but in anything that you are interested in and passionate about. Warren Buffett says, “you should do the job you love whether or not you are getting paid for it. Do the job you love. Know that the money will follow…. If you’re doing something you love, you’re more likely to put your all into it, and that generally equates to making money.” Perhaps this is the meaning of life that everyone’s intrinsically searching for.

(Image CC-BY-SA *Zara.)