{"id":926,"date":"2020-06-24T13:08:00","date_gmt":"2020-06-24T18:08:00","guid":{"rendered":"https:\/\/www.bellvest.ca\/winnipeg\/resources\/increase-retirement-income-loss-aversion\/"},"modified":"2025-09-22T15:46:46","modified_gmt":"2025-09-22T20:46:46","slug":"increase-retirement-income-loss-aversion","status":"publish","type":"resources","link":"https:\/\/www.bellvest.ca\/winnipeg\/resources\/increase-retirement-income-loss-aversion\/","title":{"rendered":"How your biases are getting in the way of achieving your retirement goals"},"content":{"rendered":"

It\u2019s human nature to opt for a sure thing when the stakes are high. In retirement, we need to know our savings will last, and the double whammy of insecurity around income and uncertainty about how long we\u2019ll be alive leads us to make investment decisions based on a fear of losses. This article explains how this fear becomes an information processing bias that can affect your investment decisions and reduce your investment income. At the end, we offer advice to manage this instinct properly to increase your retirement income.<\/p>\n

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THIS IS YOUR BRAIN ON RETIREMENT<\/h3>\n

If we knew exactly what was around the corner, we\u2019d arrive fully prepared. Instead, the future is uncertain\u2014and this is felt particularly keenly during retirement.<\/p>\n

The questions seem endless. How long will I live? How healthy will I be? What unexpected expenses will I have? When should I start drawing on my government pensions? What will the markets do? Should I go back to work? When should I convert my RRSP to an RRIF? If you have a spouse or partner, you can repeat the questions, subbing in their name for the first-person pronouns.<\/p>\n

If these questions are keeping you up at night, they\u2019re probably affecting your investment decisions. That\u2019s because periods of uncertainty magnify our underlying emotions, and emotional decision-making is more likely to be biased.<\/p>\n

HOW OUR BIASES AFFECT INVESTMENT DECISIONS<\/strong><\/p>\n

We\u2019ve explored the mental shortcuts that lead to biased information processing and how these biases affect investor behaviour in two other posts: <\/span>5 ways fast thinking is hurting your investments<\/a><\/span> and <\/span>5 more biases that are hurting your investments<\/a><\/span>.<\/span> They\u2019re excellent sources of information on biases and investing, based on Alan Fustey\u2019s book, <\/span>Risk Financial Markets & You<\/em>. (We\u2019re giving away <\/span>free copies of Alan\u2019s book<\/a><\/span> if you\u2019re interested.)<\/span><\/p>\n

For our readers in a hurry, here\u2019s a quick summary of those articles.<\/span><\/p>\n

Humans have evolved to respond quickly to life-and-death situations. Back in the primordial swamp, fast thinkers were more likely to outrun a predator and pass their genes to the next generation. Thinking quickly doesn’t allow us to systematically gather evidence and subject it to a disciplined evaluation process. Instead, we have to rely on mental shortcuts. The emotion of the moment (\u201cYikes! A tiger!\u201d) triggers the need to act quickly, which triggers our fast thinking brain and our biased information processing.<\/span><\/p>\n

The top 10 biases that can impact investment decisions are:<\/strong><\/p>\n

Herd bias<\/strong>\u2014our tendency to follow the crowd<\/span><\/p>\n

Uncertainty aversion<\/strong>\u2014our bias towards known risks<\/span><\/p>\n

Anchoring bias<\/strong>\u2014making decisions using an arbitrary reference point<\/span><\/p>\n

Confirmation bias<\/strong>\u2014seeking evidence that confirms our beliefs<\/span><\/p>\n

Availability bias<\/strong>\u2014relying on information that\u2019s top of mind<\/span><\/p>\n

Representativeness bias<\/strong>\u2014making connections between things that aren\u2019t necessarily related <\/span><\/p>\n

Affect bias<\/strong>\u2014mixing up feelings with facts<\/span><\/p>\n

Overconfidence bias<\/strong>\u2014thinking we\u2019re better than we actually are<\/span><\/p>\n

Hindsight bias<\/strong>\u2014assuming we can predict the future because we know what happened in the past<\/span><\/p>\n

Loss aversion<\/strong>\u2014focusing on avoiding loss over securing gain.<\/span><\/p>\n

It\u2019s this last bias\u2014the fear of loss\u2014that can have an unfortunate impact on your retirement income from investments.<\/span><\/p>\n

WHAT IS LOSS AVERSION?<\/span><\/p>\n

Loss aversion is the strong dislike that most of us have to loss. In fact, we dislike losing so much that we prefer avoiding a loss to acquiring a gain.<\/span><\/p>\n

Loss aversion was first demonstrated in studies by Tversky and Kahneman. The studies suggested that our brains evaluate the emotional impact of losses and gains differently, with losses producing an impact that is more powerful than gains.<\/span><\/p>\n

Other research by Kahneman<\/span> has shown that our fear of losses is more powerful than our pleasure from gains by a factor of at least 2:1. Another study found the average person is willing to risk a potential loss only if they stand to gain at least double that amount.<\/span><\/span><\/p>\n

The bottom line? We hate to lose more than we love to win.<\/span><\/p>\n

Here’s a simple example. Imagine that you have the good fortune of finding $50 on the sidewalk. You put the bill in your pocket and walk to a nearby store. Once inside the store, you reach into your pocket to pay for a purchase and discover that the bill is gone. Somehow it fell out of your pocket. How would you feel?<\/span><\/p>\n

Chances are that you would berate yourself over losing the found $50, because the loss results in a powerful feeling even though the true economic impact to you is $0.<\/span><\/p>\n

LOSS AVERSION IS WHY WE OPT FOR THE SURE THING, EVEN WHEN IT’S THE WRONG THING<\/span><\/p>\n

A fear of losses is the reason why retired investors often go for low interest-bearing GICs, treasury bills and bonds\u2014traditional fixed income retirement strategies. These investments are perceived as \u201clow-risk\u201d because there is some sort of guarantee. You won\u2019t lose anything, you tell yourself. Or not much, anyway. And not losing is better than gaining, when we\u2019re under the influence of loss aversion.<\/p>\n

The truth is, these investments are high risk retirement strategies<\/a><\/span> given today’s financial situation. In the case of GICs and treasury bills, at today\u2019s interest rates their rate of return won\u2019t even cover inflation. By the time you need the money, it\u2019ll be worth less than when you invested it. Inflation will erode the value of bonds, as well. But bonds have an additional layer of risk when interest rates are rising, since their rate of return goes down when interest rates go up.<\/p>\n

In most cases, even retired investors should have some of their investments in higher risk options\u2014investments where there is greater likelihood of increased gains over the long term, but greater risk of short-term losses. The key is to understand that even a small gain is a loss if it doesn\u2019t give you the income you need for retirement.<\/p>\n

LOSS AVERSION IS WHY WE WON’T SELL LOW, EVEN WHEN IT’S HIGH TIME <\/span><\/p>\n

Loss aversion explains our reluctance to sell investments that will result in a loss.<\/span><\/p>\n

Imagine that within your investment account you purchase two securities. If you’re like most investors, these initial purchase costs will now become your reference points for the success of your investment decisions. (That\u2019s the anchoring bias at work.) One security appreciates and one security declines. You now need to make a withdrawal from the account, so you will have to sell one security to raise the funds. You don\u2019t have any new information about either security that may influence your opinion of the future prices of the two securities. Which one would you sell?<\/span><\/p>\n

Most people would choose to sell the security with the gain, even though the transaction will produce a capital gain that will require a future tax payment. The most rational decision would be to sell the security with the loss, since no tax would be owed and the capital loss can be carried forward indefinitely for tax purposes.<\/span><\/p>\n

A study by Odean (1998) confirmed the tendency of individual investors to hold losing investments too long and sell winning investments too soon. The study analyzed trading account records for 10,000 investors at a discount brokerage firm. Throughout the study, investors\u2019 reference points were assumed to be their purchase prices. These investors demonstrated a strong preference for selling winners rather than losers.<\/span><\/p>\n

FORGET YOUR FEAR OF LOSS? EASIER SAID THAN DONE <\/span><\/p>\n

Because loss aversion is about emotion, not logic, it’s hard to overcome. A good place to start is with awareness. Look for instances when your retirement investment decisions may be motivated more by potential loss than potential gain.<\/span><\/p>\n

Some loss aversion behaviours investors need to be aware of: <\/span><\/p>\n