How A Loss Can Ruin Your Retirement

In medical school, I had a professor who told the class, “Paranoia is dangerous to your health, but it’s good for patient care.” More than 20 years later, when he sees patients in the hospital, his words still resonate. As many doctors know, that professor was visible; double-checking the dosage, investigating other causes of the patient’s complaint, and having a moderate dose of addiction are not considered excessive by many doctors. It is considered basic.

Paranoia, beneficial in one domain but harmful in others, is seen in many people managing their retirement. Loss aversion, identified in 1979 by Kahneman and Tversky in their Prospect Theory paper, is a phenomenon we all experience: feeling the pain of loss almost twice as much as the pleasure we get from an equal amount of gain.

As doctors, we are especially vulnerable to this. We work at a high level of work with people’s lives on the line. Our risk-averse mindset can affect the way we manage our finances. For those in the private sector, income fluctuations in the early years can increase this behavior. In my experience, I have seen many doctors invest less and retain more money, but have a long retirement ahead of them and not enough money to pay for it.

Of course, sometimes doctors show the opposite reaction. In Chapter 1 of his classic book The Four Pillars of Investing, Dr. William Bernstein points out that doctors are often guilty of overconfidence and not approaching finance “the way they use hard medicine.”

Fighting loss aversion doesn’t mean being stupid or taking unnecessary risks. There is a middle way.

Loss Aversion to Your Portfolio

What does loss aversion look like in our money? Similar to robust bias or availability, which we are familiar with as physicians, loss aversion is a psychological bias, not a rational investment strategy. Loss activates our amygdala and threat systems, and we are hard-wired to avoid them.

What does this look like in your portfolio? This may mean holding onto a losing investment for longer than you should, fearing to lock in that loss. Or you feel that the stock market is too volatile and thus invest in “safer” assets, even though, if you are offered a lower rate of return, it lowers your compound interest rate and may not keep pace with inflation. It is this fear of market crashes, even when people are decades away from retirement, that is most damaging.

Another behavior includes selling a rising stock or ETF soon, hoping to protect the gain and thus miss out on the increase in valuation. It can also be seen in buying financial products that you may not need, including whole (instead of term) life insurance or annuities. We all need some insurance and an element of security, but our many years of training—and the associated sunk costs—can sometimes cause more fear of financial crisis. I’ve been wondering if our “do no harm” mentality has kept some of us from taking the right risks, while others, as mentioned above, suffer from the opposite problem because of our expertise in a certain domain—despite having nothing to do with finance.

More info here:

Yes, Risk Tolerance Can Be Changed: You Just Have to Rewire Your Brain

Saving for Your Unknown Future

Solutions to Overcome Loss Aversion

What should a medical investor do? First and foremost, we have to play the long game. Saving for retirement is, well, a decades-long strategy. Observing the daily fluctuations of the market is not a smart strategy, and can lead to over-trading, hiding assets in inappropriate vehicles, and increasing your anxiety. Reframe those market corrections as part of the ups and downs of the trip across the ocean, from here to the foodie ballparks and wealthy “Retirementland.” (Or whatever your retirement fairyland might look like.)

Also, we should plan well in our investments. For those who work for institutions with automatic contributions and deferrals that increase every year, they are reluctant to change unless there are very good, well-researched reasons.

Another form of “protection” is ensuring that you are sufficiently diversified and that your asset allocation is appropriate for your risk tolerance and (in the case of Taylor Swift) a certain “period” of your life.

Finally, consider an accountability partner of some sort, an objective person who can help you properly isolate and point out when you may be making emotional, rather than rational, decisions that may conflict with your long-term goals. Even Vanguard Group, the paragon of passive diversification, notes in its “Advisor’s Alpha” that leverage can save investors about 3% a year. This is not done by beating the market, which is rarely done consistently year after year, but by finding tax efficiency, avoiding expensive cars, and preventing emotional and unproductive decisions.

In the medical field, we know more than most how fragile and fallible people can be. But we often forget that we can be fragile and fallible. We lament the poor choices of some of our patients but we often make equally poor choices. And, often, we earn very good salaries but we often struggle to build wealth. Just as we need to know how to make mistakes in patient care, we need to understand the same cognitive errors that can affect our retirement.

Have you ever suffered from loss aversion? How did you cope with it? What other money psychology issues have you faced?