I grew up around horses. My grandparents owned a horse farm and my uncle trained and rode horses. I’ve been going to horse races since I was born and the third weekend in May is always blocked off on my calendar for Preakness.
While I’m used to spending time around horses with my family, gambling was never a major part of that experience. In a few weeks my dad and I will make our annual trek to Las Vegas for the AICPA PFP conference and I’m sure that, as always, I won’t see him place a single bet. I’m more inclined to do a little gambling than him, but I hate to lose money so I’m very strict about my limits.
This year at Preakness I was having a pretty good day, winning some bets and enjoying a few Black Eyed Susans (the “official” drink of the Preakness). My 6 year old had been telling me all week he liked numbers 1, 5 and 10, and that morning he told me to pick #5 to win. We hadn’t played his numbers yet so my wife and I talked about playing them in the Preakness. Unfortunately, probably thanks to the Black Eyed Susans, I only bet the 5 and not the 1-5-10 trifecta. A trifecta is when you pick the correct 3 horses to finish first, second and third, which is harder than it sounds! To make it slightly easier, you can “box” the 3 horses, meaning those 3 horses can come in any order as long as they finish as the top 3. The plan was to bet a $2 trifecta Box with the 1-5-10 horses for $12, except I never made the bet.
You can probably guess what happened. The final finish in the race was 1-10-5. And you can probably guess my wife’s reaction when she found out I didn’t make that bet! Trying to beat the crowds, we left as soon as the race ended, not waiting for the official results. We figured we’d left a hundred bucks on the table, which was painful to think about, but not the end of the world.
Later that night at home I decided to look up the actual payout on the trifecta. I pulled up the results on Google and scrolled down to Race 13 and found out that $2 trifecta bet would’ve paid out about $9,400! I spent the night tossing and turning, not able to get that missed bet out of my head. The whole next day it was all I could think about. It’s still nagging at me several days later. Why does it hurt so much to lose something I never had?
This is exactly the kind of question the field of behavioral finance seeks to answer. It has been documented that we experience losses and gains differently. A concept called loss aversion argues that we feel the pain of losses more strongly than we experience the joy of gains. While I technically didn’t “lose” anything, since I never had the money to begin with, in my mind I should’ve had $10k at the end of the day. Instead, I walked away with nothing, so it feels like lost money.
I have to ask myself, if I had won the $10,000 would I still be thinking about it nonstop? Would I be writing this article? Probably not. I’m sure I would’ve been happy and could think of a lot of ways to spend or invest that money, but I wonder if my joy would’ve been equal to the agonizing pain of the “lost” money? It certainly feels like it hurts more to lose, even when you had nothing to lose in the first place.
It reminds me of another common behavioral trap investors fall into, regret. Anytime we see an investment that has gone up substantially in value, we can’t help but regret not having invested in it. Several companies, like Uber, Lyft and Pinterest, have gone public recently, turning early investors into millionaires. There were plenty of stories of people who turned down the chance to invest early who lost out on millions who are surely feeling regret now.
Most people don’t have the chance to be an early investor in small private companies, but anyone can buy a publicly traded stock. How many times have you heard someone say, “if only I’d invested all my money in X stock back in the day?” $1,000 invested in Amazon stock back when it went public in 1997 would be worth over $1.2 million today. Sure, you would’ve had to watch the value drop by 94% at one point, but that doesn’t stop the feeling of regret.
Bitcoin is another prime example of people feeling they missed out. As the price rose from pennies up to over $20,000 at its peak, everyone wanted to get in. The FOMO (fear of missing out) was real and nobody wanted to regret having missed out on making easy money. The price eventually crashed, but there are still many people who bought into Bitcoin in the early days who made millions. Then there was the guy who bought two pizzas in 2010 using 10,000 bitcoin, or the equivalent of about $800 million today. Talk about feeling regret!
Survivorship bias is another important behavioral finance concept to understand here. It’s easy to see the winners now and forget about the losers, but that’s only because the winners are so obvious in hindsight. Sure, you’ve heard of Uber, but what about Taxi Magic, one of the first attempts at an online taxi service? Yes, we all know how successful Amazon became, but what about pets.com or etoys.com, which both raised millions of dollars at their IPO, then went out of business completely? And yes, Bitcoin’s price has been on a roller coaster of highs and lows, but it still has value, something that can’t be said of countless other cryptocurrencies that came out of nowhere in recent years.
I’m not sharing all this simply to make myself feel better about “losing” $10,000 (well, maybe a little), but rather to illustrate how incredibly complex our emotions and feelings are around money. Developing the right investment approach isn’t simply about picking the optimal asset allocation or the best investments. You need to understand how your money impacts your life and how you’ll feel when your investments go up or down in value, or you “miss out” on a potential great investment.
Many of the feelings we have around money are built into who we are and are not something we can easily change. However, being aware of our biases and how are brains work can help us better understand why we feel or react a certain way. This can go a long way towards improving our financial outcomes. I highly recommend learning more about the field of behavioral finance and what has been uncovered about our minds as they relate to money. The Undoing Project, by Michael Lewis, Your Money and Your Brain, by Jason Zweig, and The Laws of Wealth, by Dr. Daniel Crosby are all excellent places to start.
-Chris Benson, CPA, PFS
The views expressed represent the opinions of L.K. Benson & Company and are subject to change. These views are not intended as a forecast, a guarantee of future results, investment recommendation, or an offer to buy or sell any securities. The information provided is of a general nature and should not be construed as investment advice or to provide any investment, tax, financial or legal advice or service to any person. Please see Additional Disclosures more information.