In fact, studies have shown that the pain of losing is twice as strong as the joy of winning. So, losing $100 hurts twice as much as the same feeling you'd experience gaining $100. Ouch.
However, science also shows that investing in the stock market is one of the best ways to build wealth over time. Keeping your money all in cash is actually riskier because you won't be able to grow your wealth faster than inflation – meaning that your actual spending power will be less (i.e. you'll feel poorer in retirement). But recent events (the stock market crash of 2008) have reignited a lot of fears around investing.
Let's see if we can build some strategies to help overcome the fear of losing money in the stock market.
The Science Behind Fear
Fear is an incredibly personal experience. That's why some people are afraid of flying while others fly every week. Or some people are afraid of heights and others work in skyscrapers.
But there is some science behind why people are afraid of things, including losing money. While there is still a lot of research to do around the subject, scientists understand what makes your body feel fear, and have begun to understand how each person experiences fear differently.
Fear is “learned” from three things: a past personal event, the experiences of family and friends, or a contagious “herd” experience. When looking at the fear of say, spiders, you could have become fearful because you were bit by a spider at a young age, or you watched a horror movie involving spiders when you were young. Or, your family members could have brought you up with a fear of spiders because of their own fear of spiders – you just picked up on the fear and continued it.
The herd mentality is a little tougher to quantify, but it's more along the lines of – since everybody else is afraid of spiders, I guess I am too. In the spider example, maybe you've been watching news reports on spiders that included interviews with others. Or you were in a room and others started screaming about a spider. These are examples of how you get a “herd fear“.
What you experience fear, you body kicks in some heavy duty hormones which are designed to save your life. First, you body is on constant alert for potential predators and fearful objects – it's constantly comparing current experiences to past events and deciding if this is “good” or “bad”. If it encounters a bad fear trigger, the first reaction is typically a freeze response – your body just stalls and waits. Meanwhile, it's building up other chemicals to increase your ability to “fight or flight” – either to defend yourself or get you out of the situation. Then, if the fear trigger isn't abating, your body will kick in adrenaline and either get you out of the situation or increase your ability to fight off the “attacker”.
Looking At The Fear Of Losing Money Specifically
The fear of losing money can come from all three of these triggers.
You can have personally experienced a loss in the stock market. Maybe you had some money saved in your 401k, and you watched the value of it decline by 40-50% in 2008. Or maybe you've always been living paycheck to paycheck, so the thought of putting your money in an account and it not being there scares you since you fear not being able to pay the bills.
Maybe you inherited a fear of losing money from your family – maybe it was your parents who suffered large losses in their 401k in 2008 and then had to work longer to be able to retire. Or maybe you simply heard your parents discussing their money problems growing up and it left you worried about it.
Or maybe you picked up a fear of losing money from watching too much TV. Shows like Suze Orman, while providing advice, also highlight a lot of people who are struggling. Or even the local news each night – they only give a headline: the market dropped 84 points today – and you have no context about it beyond that. So your mind wanders and you worry.
How The Fear Of Losing Money Plays Out
Now that you understand the science of fear and how your body reacts, it makes sense that people do one of two things when it comes to money when they are fearful of losing it:
- They do nothing and avoid the subject
- They do too much and get into trouble
First (and most common), they do nothing. Since the fear of losing money triggers fear, and the body's first reaction is to freezer, they get stuck frozen with money. They don't want to take action. And since money doesn't require any “fighting”, your body and mind simply get you safely away from the fear through flight. However, this prevents you from making money decisions and could also lead to future problems.
The second (and far less common approach), is to do too much. In this case, it's typically someone who is investing, but is so afraid of losing money, that they are trading constantly to lock in small gains and avoid losses. However, in this situation, the person can also get into trouble because they are spending money to make trades (via commissions), and they aren't letting their money grow over the long term (losing potential returns).
Setting Up Your Investments To Avoid Fear
Now that you understand the science behind the fear of losing money in the stock market, there are a few simple tricks that you can do to help you overcome these fears. These are also based in science, so let's look at the science of overcoming fears and how it applies to money.
Key Steps To Overcoming Fear
If you want to overcome any fear, including the fear of losing money investing, you have to go through the following steps:
- Acknowledge it and try to define where it came from or how you “learned” it
- How does this fear affect you (i.e. you do nothing)
- Analyze every possible outcome of decisions you fear, including the worse case scenario – don't be afraid to write it out
- Take control of your fear – confront it directly using loss aversion
- Understand that fear will always have a place in your life
Applying This To Money And Investing
First, you need to look at your fear and see where it came from. Maybe your parents or friends? Realize that your financial situation is not the same as their's and it never will be. Plus, in money and finances, it's highly unlikely that you will ever know their full story. Maybe they also made mistakes with money that you weren't aware of? Maybe they did things they didn't share? If your fear is based on others, ask yourself how much you really know about their money, spending, and investing?
The next step it to address how this fear affects you. For most, fear of losing money paralyzes, and you don't invest. The solution to this is to automate and not look at your money. For example, you could start investing through an employer's 401k plan. Simply setup the contributions to be automatically withdrawn from your paycheck, and don't look at your 401k balance. By not having to make a decision, you're making a decision to invest but you don't have to worry so much about it.
Beyond automation, you can also define every outcome of investing. You could gain 5% or lose 5%. Your worst case scenario may be losing 90%.Write each situation down and see what it looks like for the money you have. Just knowing that can happen makes a big difference. If you want to automate this process, use a calculator like FireCalc, which shows you the probability of what will happen to your money over time.
Next, you can use loss aversion – which is a fancy term for making the pain of loss work to your advantage. Remember when we said pain hurts twice as much as gain? Well, that's the premise. If you want to contribute to an IRA, you could setup weekly payments of $105 to max your contribution. If you confront your fear directly and start investing with the goal of investing each week, missing 1 week will be more painful to you than not investing. You mind changes your thought process on what hurts.
Finally, the last thing to remember is that you'll always have fear in your life, and that's okay. The important thing to remember is to control it so it doesn't control you. This is even more important when it comes to investing and money, because it's a scary thought to never invest and then be poor when you're 65.
How do you feel when the market drops? Have you included these events in your financial plan?