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Gain and Loss Learning

| | Posted in: Individual Investing

Do distinct neural processes for rewards and punishments result in distinct variation in learning about financial gains and financial losses? If so, is such variation material to wealth-building? In their September 2011 paper entitled “Gain and Loss Learning Differentially Contribute to Life Financial Outcomes”, Brian Knutson, Gregory Samanez-Larkin and Camelia Kuhnen examine whether individual differences in gain learning and loss learning relate distinctly to cumulative financial outcomes. Specifically, they relate gain and loss learning separately to self-reported measures of assets and debts (as partially corroborated by credit reports), controlling for other potentially confounding individual characteristics. Using results of a financially incentivized learning experiment involving a representative sample of 75 San Francisco area residents, they find that:

  • Rapid learners tend to have smaller debt-to-asset ratios than slow learners.
  • Even after controlling for intelligence, memory, risk preferences, age, sex, ethnicity, income and education:
    • Those who learned rapidly about gains tend to have more assets.
    • Those who learned rapidly about losses tend to have less debt. 

In summary, evidence from a controlled experiment suggests that individual investors may want to analyze the performance of their gains and losses separately over time to confirm learning (improvement) for each separately.

Cautions regarding findings include:

  • Experimental tests may not accurately represent actual investing.
  • The learning model in the study is linear, not taking into account potentially disproportionate impacts of extremely large gains and losses.
  • Statistical significance tests assume tame (normal) distributions of wealth measurements, which may not hold.
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