This is a fascinating piece about how golfers, consciously or unconsciously, behave more conservatively on birdie putts than on par putts, costing themselves—on average—a full stroke over 72 holes, and for a top golfer, more than $1 million in annual prize money. The reason for their conservatism is loss aversion, a psychological phenomenon noted by Nobel Prize winner Daniel Kahneman and his collaborator, Amos Tversky. In short, people try harder to avoid perceived losses than they pursue gains. Kahneman realized loss aversion is in full bloom in the financial markets, which is why (among other related investor irrationalities) he was awarded the Nobel Prize.
Articles like this point out why it is so important to have a systematic, rules-based approach to the markets. By doing so, we are able to treat every putt the same way, so to speak. A systematic approach does not vary depending on whether our last transaction was a success or a failure, or whether we’ve recently been outperforming or underperforming. We just keep pounding away at a strategy that has been shown to add value over time. By not pulling any psychological punches, we are more likely to capture whatever excess returns are available in the strategy.
—-this was originally published July 7,2009. Loss aversion reared its ugly head last year when investors became inordinately attracted to low bond yields. Now that yields are rising-and bond prices are dropping, with an assist from Meredith Whitney-the cost of loss aversion is becoming clear. To win, you have to play to win. You’re in trouble if you play to not lose.
