The High Cost of Emotion in Personal Finance
Our rational side knows market timing is a fool’s game. Yet, short-term trends sometimes drive our decisions.

Humans are hard-wired in ways that helped our ancestors survive over thousands of years. Investing in markets is a recent concept – the New York Stock Exchange (NYSE) was founded in 1817. Unfortunately, the cognitive processes that aided our ancestors may undermine our success in modern markets. Behavioral finance is an emerging field that examines how people use the tools of finance, rather than studying the tools themselves.
One common behavioral mistake is known as “myopic loss aversion.” Behavioralists have estimated that people hate losses roughly two-and-a-half times as much as they like gains. We exert more effort to avoid losses than to achieve gain. Suppose an investor’s portfolio rose 40% and then dropped 20%. He/she would feel the loss about 2.5 times as much as the gain. The drop causes heightened loss aversion, potentially leading the investor to panic and act against what he/she knows is rational.
Researchers measured the cost of this approach by comparing the performance of return chasing with a buy-and-hold strategy. The research reveals return chasing leaves nearly 2% on the table annually. Rather than earning 10% annually over the long term, those impaired by the recency bias took a 20% haircut and ended up with 8% annualized returns.

Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
Understanding the lessons of behavioral finance can greatly increase your odds of achieving financial freedom. Realizing that these tendencies exist is the first step in making better decisions. Remember, we hate losses roughly two-and-a-half times as much as we like gains. Fight the urge to panic over investment losses, and realize our tendency to overreact to recent history. Working with a financial adviser can help you stay on track. It’s easy to get emotional when managing your own money. An objective partner can help you overcome harmful behavior biases and remain focused on long-term goals.
Sources: Bloomberg, CFA Institute, Wall Street Journal, About Archeology, Federal Reserve Bank of St. Louis, Investment Company Institute, Morgan Stanley International
David has served as CEO of Mercer Advisors since 2008. He is responsible for the firm’s strategic vision, business plan execution, and organizational structure.
Get Kiplinger Today newsletter — free
Profit and prosper with the best of Kiplinger's advice on investing, taxes, retirement, personal finance and much more. Delivered daily. Enter your email in the box and click Sign Me Up.

-
Ask the Editor — Questions on the One Big Beautiful Bill
Ask the Editor In this week's Ask the Editor Q&A, we answer tax questions from readers on the House-passed “One Big Beautiful Bill.”
-
Stock Market Today: Stocks Bounce as US-China Tensions Escalate
Stocks were volatile to end the week and the month amid concerns a trade truce between the U.S. and China is splintering.
-
How One Widow Nearly Missed Out on $213,000 in Social Security
Losing your partner often means losing 30% to 50% of your household income. This financial adviser emphasizes that planning ahead and understanding the rules surrounding survivor benefits can help.
-
Simple Ways to Make Your Executor's Job Less of a Pain
Being an executor of an estate isn't easy, so you should do what you can to help them out. It can be as easy as making a list and being smart about your email accounts.
-
'Trump Accounts' for Newborns: A Great Idea That Could Be Better
According to this financial professional, limitations on the proposed $1,000 deposit at birth highlight shortcomings in our retirement landscape, but the potential is there to make a big difference.
-
Opportunity Zones Expert Sees Bright Future in 'Big, Beautiful Bill'
New legislation introduces rural "super incentives" and expanded access, though a potential investment freeze could stall billions in community development funding. Here's what every investor needs to know.
-
Sorry, But AI Alone Doesn't Cut It for Financial Planning
Artificial intelligence has its place in retirement planning — but only as a tool. It falls short in several key areas that require a human touch.
-
Five Divorce Settlement Blind Spots: An Expert's Guide to What You Can't Afford to Miss
Even the best lawyers can miss tax and other financial considerations when drafting complex divorce settlements, so specialist advice is vital from the outset.
-
Preparing for the Worst: Retirement During a Recession
If you're close to retirement and today's economic uncertainty has your stomach in knots, follow my parents' example. They made it through, and so can you.
-
Is a Robo-Adviser Right for You? The Pros and Cons
For many folks, robo advice can likely be fine. It's inexpensive and easy ... but also a little one-size-fits-all. More complex financial situations may need a human touch.