Loss aversion

Adviser Insights by Elmarie da Silva

Most investors believe they are rational. They assume that when markets move, they will respond logically, based on facts, long-term planning, and a clear understanding of their goals. But when markets fall, something very different happens. Rational thinking is often replaced by emotion. And that emotion is one of the most powerful forces in investing: loss aversion.

Loss aversion is a concept from behavioural finance that explains a simple but critical truth, losses feel significantly more painful than gains feel rewarding. In practical terms, losing R100,000 does not feel equal to gaining R100,000. The emotional impact of the loss is far greater. That imbalance creates urgency, and urgency leads to action. In most cases, that action is selling. This is not because the investment strategy has fundamentally changed. It is because the discomfort of the loss becomes too difficult to ignore.

For South African investors, this behaviour is often intensified by the environment in which they operate. Markets are influenced not only by global movements, but also by local economic pressures, currency volatility, and ongoing political and fiscal uncertainty. The Rand itself adds another layer of complexity, strengthening or weakening in ways that can make offshore investments feel unpredictable. When markets decline under these conditions, it rarely feels like a normal cycle.

Instead, it feels like something is fundamentally wrong. That perception is what drives reactive decision-making.

The pattern is consistent and, over time, costly. Markets decline, portfolios drop in value, and discomfort increases. Investors begin to question their strategy, not because it is flawed, but because it is uncomfortable. The natural instinct is to reduce risk, move to cash, or exit the market entirely. At the time, this feels responsible. But it is rarely strategic. Because markets do not wait for confidence to return. Recovery often begins before the news improves, before sentiment shifts, and before investors feel comfortable enough to re-enter. By the time they do, much of the recovery has already happened.

In South Africa, this behaviour carries an additional consequence that is often overlooked, tax. Selling an investment may trigger Capital Gains Tax (CGT), depending on the structure. A portion of the gain is included in taxable income and taxed at the investor’s marginal rate. At the same time, exiting the market interrupts compounding. Even short periods out of the market can have a significant long-term impact, particularly when those periods coincide with recovery phases.

This is where proper financial planning plays a critical role. Different investment structures are not just about tax efficiency, they also influence behavior. Retirement annuities limit access and reduce impulsive decisions. Endowments provide tax efficiency. Discretionary portfolios require more discipline. A well-constructed portfolio creates a framework that supports long-term decision-making.

A proper financial strategy is not designed to avoid market movement. It is designed to help you remain invested through it. Because markets recover but only for those who are still in it.