The Fear Of Loss And The Fear Of Risk – Only One Fear Is Beneficial

Many investors are afraid of losses. They don’t even know their fear of loss or only notice it when it’s too late. I recognize them when they invest in a company with conviction and enthusiasm. If the share price then falls or does not increase in value, they quickly become impatient, nervous, and fearful.

I can cope surprisingly well with price drops of 60 percent or even more. But that has less to do with the fact that I like to torture myself. It’s more about my fear of risk. It ensures that I am aware of the risks and try to avoid them as much as possible. Hence, I don’t gamble much with high-flyer stocks. And if I bet a little, I gamble knowing that it can backfire badly. Knowing the risk takes away my fear of loss.

Accordingly, it is important to separate the fear of loss from the fear of risk. So it’s time to bring the two aspects face to face.

The fear of loss

The fear of loss is something that we encounter in many areas of life. It is not only financial but also personal or health-related. Two characteristics of this fear are crucial. First, the fear always refers to something existing. Second, the fear of loss is always the fear of being inactive.

Fear of loss always refers to something existing

The fear of loss always refers to something existing. We can only lose something if we have the feeling that we possess something.  It doesn’t matter whether it’s emotional possessions like friendships or material possessions like stocks.

Fear of loss corresponds to a sense of belonging. There’s something, I have it, and I could lose it. Fear of loss is always directed toward an existing position and is an expression of concern that I might lose that position. Thus, fear of loss is very human. It is deeply rooted in the assignment and belonging of people to people (family, society, national states) and people to objects (property).

Fear of loss is the fear of being inactive

The second essential characteristic of fear of loss is that we could also call it fear of being inactive. When we are afraid of losses, we want to protect ourselves against the occurrence of these losses. So we have to take active action. Inactivity is not an option because the loss of the existing position is imminent.

This compulsion to act is the revenge that fear of loss always refers to a current position. A risky position in our balance sheet remains a risky position. We can insure this position, but then we create a second risky position, and one of them will lose. So it’s a zero-sum game in the first place, which becomes a loss thing in the second place because of the risk premiums we have to pay.

When fear of loss causes loss

Fear of loss motivates action and thus often creates the actual loss in the first place as loss-limiting actions often give a false feeling of control and mastery of risks. When the market crashes, many investors sell their shares to limit the losses and feel good about it when the shares then fall further in the short term.

However, it is a common misconception that such actions provide greater security. Thus, a frantic sale of that position may allow us to limit the loss. But we have nevertheless suffered a loss. Besides, such measures are often accompanied by emotions. And it has been proven that emotional decisions are often the wrong ones. Stocks that fall in a crash can bring excellent profits again in the next bull market.

Fear of loss, therefore, forces action and market timing. It thus forces us deep into the mire of all the things that will always fail in the long run, namely emotion-driven action and attempting to predict future market prices.

The fear of risk

The fear of risk is something completely different. It concerns a decision that has yet to be made. So it is not about a decision that has already been made. Essentially, it is the difference between “holding options” and “holding a position”.

This difference sounds marginal, but in consequence, it is as significant as the difference between fragile and antifragile. I would always choose the fear of risk when in doubt because it has many advantages.

The fear of risk is the fear of action

While the fear of loss is the fear of being inactive, the fear of risk can be seen as the fear of action. We are afraid to increase our risk exposure with a decision.

The first impulse is to avoid the risks as we wouldn’t benefit from increasing our risk exposure, which ensures that many possible losses for us do not occur.

In addition, we look more at why it might be worth taking a risk position after all. Automatically, we take a closer look at the risk/reward ratio.

Those who do not take action still have all options

Those who do not take action still have all options. Options always go hand in hand with antifragility.  Therefore, keeping options open is an important rule when it comes to risk management.

Having options provides flexibility. We don’t have to chase every hype.

Furthermore, not having to be active protects against the really big mistakes:

When we make particularly risky investments for our assets, we are not allowed to be wrong very often. From my point of view, a wrong decision is mainly the following: irreversible losses.

Irreversible losses are the actual yield killers and thus the real mistakes in investing. Not achieving the very best return is not a mistake. It is, as I said, just not the very best return. You can see the impact of wealth-destroying events or mistakes in the chart below. Even for an investor who has a higher return because of his risky strategy, such events significantly impact the overall performance.  Not in a good way.

Let’s assume that a high-risk investor achieves an annual return of 10 percent. The initial capital was 10,000 USD/EUR, and the yearly investment 4,000 USD/EUR. With three extreme events of losing 50 percent of the assets twice and 25 percent once, this investor did worse after 50 years than the investor with an annual return of only 6 percent.

Inactivity associated with fear of loss

In discussions, a friend pointed out the following argument to me. Being inactive is a possible option in the case of fear of loss too. He referred me to the example of a share with a poor share performance. Investors can also decide to remain inactive because they do not want to risk missing the turnaround.

My friend is correct in making that argument. Staying inactive is an option. However, doing nothing is always an option. So that’s not the kind of risk anxiety I’m talking about because the risk in the example above has already occurred due to the potential loss position. I can no longer be afraid of risk if I already bear it. I can now only be afraid of the risk materializing and the loss occurring.

Note: Fear of risk always sets in before one’s risk exposure increases. Closing a risk by selling shares or holding the position does not change the risk exposure, at most the quantitative outcome of the risk.

Both fears affect the financial and personal world

A healthy lifestyle is important, which includes plenty of exercise as well as a healthy diet. Those who live a healthy life reduce the risks of suffering serious illnesses.

Of course, there are no guarantees in life. And if we look at a disease in isolation, it would be foolish to assume we can avoid it by living a better lifestyle. Randomness plays far too great a role for us to believe that we can safely escape disease through lifestyle.

Accordingly, we must simply accept that we can lose our health at any time. So fear of loss does not help and does not give us control.

Fear of risk also cannot protect us from the concrete danger of individual diseases, but it at least helps to decrease the abstract risk of getting diseases in general. How can that be the case?

We need to keep in mind that diseases also benefit from serendipity. The more we expose ourselves to specific stressors, the higher the risk of getting sick. So we cannot prevent individual diseases, which is why the fear of loss is ineffective, but we can reduce risks and limit the scope of serendipity.

I, therefore, prefer to avoid too risky lifestyles and incidentally try to live a hedonistic life. I also try to fade out fears of loss as far as possible. Like other fears, fear of loss can express itself on the level of feelings, thoughts, and behavior. The predominant emotion is, of course, fear, but we can also feel sad, depressed, dissatisfied, or frustrated with loss anxiety.

Again, we see the difference: fear of risk leads to avoidance of risk, leads to the absence of fear. Fear of loss itself is associated with negative physical aspects.

High-level overview

In the following, I have compared some characteristics of the two fears. The list can be extended at will.