Pizza! Most of us love it. Some love themselves a traditional Margherita, while others prefer a fully loaded Chicago deep-dish. So what does pizza have anything to do with the psychology of investing?
Irvin Levin, a Psychology professor, conducted an interesting experiment where participants had to either build their own pizza by adding toppings to an empty pizza base, or remove toppings from a fully-loaded one. The experiment wanted to find out which action, either adding or subtracting, would result in a fuller and more expensive pizza. Wanna warrant a guess?
The results were largely consistent across participants from different countries, and it was the subtracting method that resulted in a much more expensive pizza with more toppings. This could be due to the participants being less willing to lose than to gain. This is an example lending to the concept of loss aversion and the endowment effect.
In the world of psychology and behavioural economics, studies on loss aversion have shown that humans generally give more weightage and significance to a loss compared to an equal amount of gain. The endowment effect is a theory that suggests we place more value on things that belong to us. So, how does all of this relate to investing?
These are examples of emotional biases that affect our behaviour in investing. Good investing advice encourages us to use rationale and math over emotion when investing. Loss aversion and the endowment effect might lead us to hold on to investments that should be cut to prevent major losses. We should be careful not to let the inflated fear of losing cause us to lose in actuality.
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