In medical school, I had a professor who told the class, “Paranoia is terrible for your personal life, but it’s great for patient care.” Over 20 years later, when seeing patients in the hospital, her words still resonate. As most doctors know, that professor was spot on; double-checking a medication dosing, investigating alternative etiologies of a patient’s complaint, and having a moderate dose of obsession is not considered excessive for most physicians. It’s considered baseline.
Paranoia, beneficial in one domain yet harmful in others, is also seen in many people managing their retirement. Loss aversion, identified in 1979 by Kahneman and Tversky in their paper on Prospect Theory, is a phenomenon we all experience: feeling the pain of loss about twice as strongly as we feel the pleasure for an equal amount of gain.
As doctors, we are especially at risk for this. We work in a high-stakes profession with people’s lives on the line. Our risk-averse mindset can influence how we manage our finances. For those in private practice, the initial income volatility of the early years can heighten this behavior. In my experience, I have seen many physicians under-invest and hold too much cash, only to be looking at a long retirement ahead of them and insufficient funds to cover it.
Of course, sometimes doctors exhibit the opposite reaction. In chapter 1 of his classic The Four Pillars of Investing, fellow physician William Bernstein points out that physicians are often guilty of overconfidence and of not approaching finance “with the same rigor that they do medicine.”
Countering loss aversion does not mean being foolhardy or taking unnecessary risks. There is a middle path.
Loss Aversion in Your Portfolio
What does loss aversion look like in our finances? Much like anchoring or availability bias, with which we are familiar as physicians, loss aversion is a psychological bias, not a rational investment strategy. Losses activate our amygdala and threat systems, and we are hard-wired to avoid them.
What does this look like in your portfolio? This could mean holding on to a losing investment longer than you should, afraid to lock in that loss. Or possibly you feel the stock market is too volatile and thus you invest in “safe” assets, even though, given a low rate of return, it slows your rate of compound interest and possibly doesn’t even keep up with inflation. It is this fear of a market downturn, even when people are decades from retirement, that is the most detrimental.
Other behaviors include selling a rising stock or ETF too soon, hoping to protect the gain and thereby missing out on further increased valuation. It can also manifest itself in purchasing financial products that you may not need, including whole (instead of term) life insurance or annuities. We all need some insurance and a portion of safety, but our many years of training—and the related sunk costs—can sometimes cause an increased fear of financial setbacks. I have often wondered if our “do no harm” mentality has kept some of us from taking appropriate risk, while others, as mentioned above, suffer from the opposite problem due to our expertise in a particular domain—despite it having nothing to do with finance.
More information here:
Yes, Risk Tolerance Can Be Modified: You Just Have to Rewire Your Brain
Saving for Your Future Stranger
The Solutions to Beating Loss Aversion
What is a physician investor to do? First and foremost, we must play the long game. Saving for retirement is, ideally, a decades-long strategy. Obsessing over the day-to-day fluctuations of the market is not a sound strategy, and it could lead to overtrading, hiding assets in inappropriate vehicles, and increasing your anxiety. Reframe those market corrections as part of the ups and downs of a trip across the ocean, from here to the pickleball fields and the grandkid-rich “Retirementland.” (Or whatever your retirement fairyland may look like.)
Also, we must be systematic in our investing. For those who work for institutions with automatic contributions and planned yearly increased deferments, be loath to change them unless there are very good, highly researched reasons.
Another form of “protection” is making sure you are adequately diversified and your asset allocation is appropriate for your risk tolerance and (with respect to Taylor Swift) the particular “era” of your life.
Lastly, consider an accountability partner of some sort, someone objective who can help you appropriately diversify and point out when you may be making emotional, rather than rational, decisions that could be counter to your long-term goals. Even the Vanguard Group, the paragon of passive diversification, notes in its “Advisor’s Alpha” that assistance can save investors approximately 3% annually. This is done not by beating the market, which is rarely done consistently year over year, but by finding tax efficiencies, avoiding high-cost vehicles, and preventing emotional and counterproductive decisions.
In the medical profession, we know more than most how fragile and flawed human beings can be. But we often forget we can be just as fragile and flawed. We lament the poor choices of some of our patients but often make equally poor choices. And, in general, we make excellent salaries yet often struggle to build wealth. Just as we must know how we can make mistakes in patient care, it behooves us to understand the similar cognitive errors that can derail our retirement.
If you need extra help with planning for retirement or have questions about the best way to save your money in tax-protected accounts, hire a WCI-vetted professional to help you figure it out.
Have you suffered from loss aversion? How have you counteracted it? What other money psychology issues have you struggled against?