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Is Loss Aversion Causing Investors to Shun Equities

Instead, they have continued to overwhelmingly invest in the perceived safety of investment-grade bonds. During this period of almost four years of exceptional absolute performance for equities, investors have poured more than $1.2 trillion into bond mutual funds and exchange-traded funds (ETFs), but less than one-tenth of that amount ($91 billion) has gone into similar equity vehicles (see Exhibit 1, page 2, right chart). The following article posits that individual investors’ recent avoidance of equities may be driven in part by the tumultuous market environment and a human behavioral bias known as loss aversion . Why might U.S. investors be allocating less capital to equities? Before introducing the influence of behavioral biases on decision making, it is important to note that there may be perfectly rational explanations why some investors have shifted their portfolios to lighter allocations to equities in recent years. One is related to the general graying of the U.S. population, whereby more investors approaching or entering retirement may gravitate to a more conservative portfolio mix. In addition, during the past several years, market downturns may have reminded investors that equities are generally more volatile assets. It is possible that some investors recognized that their prior allocations to equities were too high relative to their long-term objectives and adjusted their portfolio mix accordingly. However, these rational explanations for the recent lack of investment in equities may not be telling the whole story.