A fund can earn 10% a year while the average person invested in it earns 7%.
The fund didn't lie, and neither did the market. The difference comes from when people bought and sold. That is level 4 of the Wealth Principles pyramid: your own behavior.
The problem: a brain built for the savannah
In 1979, psychologists Daniel Kahneman and Amos Tversky published prospect theory, work that later helped Kahneman win a Nobel prize. One of its central findings: losses hurt roughly twice as much as equal gains feel good. Their later estimate of this "loss aversion" coefficient was about 2.25.
That asymmetry was useful when a loss meant a lost meal. In markets it pushes us to sell in panic near the bottom and buy in euphoria near the top.
Quick check. You are offered a coin flip: heads you win €150, tails you lose €100. Would you take it?
The bet is in your favour, yet most people say no. If you did too, you have just felt loss aversion first-hand.
The cost: three studies, one pattern
1. Individual investors. Barber and Odean (2000) followed 66,465 households from 1991 to 1996. The most active traders earned 11.4% a year, while the market returned 17.9%. The cause the authors point to is overconfidence.
2. Day traders. Barber, Lee, Liu and Odean (2014) studied day traders in Taiwan from 1992 to 2006. Less than 1% of them could predictably and reliably earn positive returns after fees.
3. Fund investors. Morningstar's Mind the Gap 2024 found the average dollar invested in US funds earned 6.3% a year over the decade to 2023, about 1.1 percentage points less than the funds themselves. The whole gap comes from the timing of purchases and sales.
None of these people were lazy. They were too active at the wrong level.
Why checking more often makes it worse
Shlomo Benartzi and Richard Thaler called it myopic loss aversion. The more often you look at a portfolio, the more often you see a loss, and every loss counts double. They showed that the historically large premium of stocks over bonds fits investors who evaluate their portfolio about once a year.
The longer your evaluation period, the less often you see red, and the easier it is to stay put.
Five biases that cost the most
- Overconfidence. "I know more than the market." Costs you: overtrading and fees (Barber & Odean).
- Disposition effect. Selling winners early and riding losers long. Costs you: cut gains and extended losses (Shefrin & Statman; Odean 1998).
- Anchoring. Your buy price becomes "the" price. Costs you: decisions based on a number the market ignores.
- Recency. The last few months feel permanent. Costs you: buying high after rallies, selling low after drops.
- Herding (FOMO). Buying because everyone is. Costs you: entries close to the top.
The fix: two options, no third
Our position is uncompromising. You have exactly two exits:
- Don't act. Diversify, automate contributions, rebalance on a schedule and stop looking at the balance.
- Build a system that decides for you. Write rules in advance and follow them, with no human input at the moment of decision.
What does not work is relying on willpower in the moment. Kahneman spent a lifetime showing that knowing about a bias does little to stop it. Changing the environment does.
The behavior rule: don't try to beat your psychology with willpower. Build an environment where it never gets a vote: rules written in advance, automatic contributions, infrequent check-ins.
This is exactly why we are building Pace: rules beat tips, and a system applied to your own numbers beats a decision made at 2 a.m. after a red day. See how it works.
If you haven't yet, start with the map: Wealth Principles, the six-level pyramid, and calculate your freedom number.
Your checklist
- Count how many trades you made last year, and what they cost in fees.
- Set a review rhythm (monthly or quarterly) and remove price alerts you don't act on.
- Write three rules you will follow in a 30% drawdown, before it happens.
- Automate your contribution on payday.
- For every future trade, write one sentence: why now, and what would prove me wrong?
Sources
- Kahneman, D. & Tversky, A. (1979). Prospect Theory: An Analysis of Decision under Risk. Econometrica, 47(2), 263–291. Link
- Tversky, A. & Kahneman, D. (1992). Advances in Prospect Theory. Journal of Risk and Uncertainty, 5(4), 297–323. Link
- Barber, B. M. & Odean, T. (2000). Trading Is Hazardous to Your Wealth. Journal of Finance, 55(2), 773–806. Link
- Barber, B. M., Lee, Y.-T., Liu, Y.-J. & Odean, T. (2014). The Cross-Section of Speculator Skill: Evidence from Day Trading. Journal of Financial Markets, 18, 1–24. Link
- Morningstar (2024). Mind the Gap 2024: A Report on Investor Returns in the US. Link
- Benartzi, S. & Thaler, R. H. (1995). Myopic Loss Aversion and the Equity Premium Puzzle. Quarterly Journal of Economics, 110(1), 73–92. Link
- Shefrin, H. & Statman, M. (1985). The Disposition to Sell Winners Too Early and Ride Losers Too Long. Journal of Finance, 40(3), 777–790. Link
- Odean, T. (1998). Are Investors Reluctant to Realize Their Losses? Journal of Finance, 53(5), 1775–1798. Link
Educational content, not financial or investment advice. Nothing here recommends buying or selling any specific instrument. Investing carries the risk of loss.