When‘s the last time you backed out of something to prevent losing something valuable to you?
Maybe you backed out of an investment in the fear of losing money, or maybe you quit one of your passions in the fear of losing your wife…
Loss aversion affects our lives in ways we can’t imagine. It runs much deeper than these examples, and the topic can actually get quite complicated.
Loss aversion bias is a cognitive bias that impacts your decision making, almost never in a good way.
It prevents you from reaching your goals, impairs your ability to grow as a human being, and causes you to let go of dreams and desires.
Want to learn what the effects of loss aversion are and how you can take back control?
Then read on!
Loss aversion definition
Loss aversion bias is a cognitive bias that refers to people’s tendency to prefer preventing a loss than gaining something. The moment we have something in our possession, we prefer not to lose it than to gain something else.
This is even the case if we only perceive to possess something without actually possessing it. This is where framing comes in as an important part of loss aversion.
(Not what this article is about, more on framing in another post.)
Your expectations of an outcome can also cause loss-aversion bias. Just the fact that you expect something to happen can cause you to feel loss averse too. We often see this in gambling and sports.
Loss aversion is an important part of decision theory and cognitive psychology. It‘s also a huge part of behavioral economics.
Loss aversion is not to be confused with risk aversion, which is the aversion of risk instead of a loss.
They’re very similar, but there is a subtle difference.
The endowment effect is another similar cognitive bias. The endowment effect, however, focuses on the increase in perceived value once a person owns something. Another subtle difference, but an important one!
We can often explain the endowment effect using loss aversion. That’s for another post though!
Loss aversion was first discovered by Daniel Kahneman and Amos Tverski. We often see both Kahneman and Tverski in the references and sources parts of various articles; this one included!
Since they first coined the term, much research has been done on the topic.
How does loss aversion affect your daily life? This story gives you a real-world example of how it might do so and helps you discover loss aversion bias in your own life!
This story is about Matthew. He was a smart little fellow who adored nothing more than guzzling down energy drinks in the early morning while staring at candles jumping up and down.
No, he wasn’t an exorcist…
He was a day trader, trading hundreds of thousands of dollars worth of natural gas and oil every day.
One morning, he got off to a better start than usual.
He was already up by $1200 in the first 45 minutes of trading. He felt his heart pounding as a wave of ecstasy rushed through his body.
It was the first time he’d ever made this kind of return!
He knew he had a winning streak going. At half-past twelve, he grabbed his fifth energy drink of the day and opened his fourth trade. After 12:00 is not the best time to trade, but Matthew felt unstoppable!
His stock gradually started to drop in value. By 14:00 his position was down $820.
He was on a winning streak though and didn’t want to lose the money he’d earned.
By the time the market closed,
he was down about $1500.
He held his position overnight.
The market opened the next morning and his stock had plummeted again.
He was down about $2500 now.
After a lot of pondering, he closed the losing trade.
In this story, there are multiple examples where loss aversion bias negatively impacted his day.
The first is when he labels his few
wins as a winning streak. Once he does this,
he immediately feels he is losing something
by not trading. This causes him to make the error of
trading when he shouldn’t be, even though he had
already earned a lot that day.
The second case is when he doesn’t let go of the losing stock.
You may think this isn’t loss aversion. After all, if he didn’t want to lose anymore, he should have closed the losing trade asap.
While this is true, it’s not what people experience. As long as a position is open, you haven’t technically lost money on the trade since it’s not closed yet.
Loss aversion is a strong bias in the stock market. There are many more scenarios where the loss aversion bias has a firm grip on people, though.
Loss attention is an alternative to loss aversion. It’s based on the same theory and are both often seen as the same thing.
However, the word “loss attention” suits certain situations better than “loss aversion”.
When a loss gets closer or you have minor losses during a task, the attention you place on that task rises.
For example, the moment you’re losing in a sports game, you pay more attention than when you’re winning.
Where does loss aversion come from?
It’s thought that loss aversion is a cognitive bias passed down through generations. Modern humans have been around for about 200.000 years (Wikipedia), and it’s thought most cases of evolution take about one million years. (Phys.org)
Needless to say that the rate at which our society has changed over the past 200 years, let alone 200.000 is alarming. Our brains just can’t keep up!
In the past, losing something was a disaster. Lose your water and you die. Lose your food supply and you die. Lose your tribe and… no prizes for guessing this one, you die!
Now, we’ve got more pointless things on earth than hairs on our head. If you’re reading this post you’re hooked up to the internet and you have some kind of infrastructure set up in your country.
Losing some money, a bottle of water or even your home is most likely not a life-or-death scenario. Sure, it’s a pain and can be traumatizing, but it’s not like it was 200.000 years ago.
It’s more important than ever to take a risk in life. Holding on tight to what you have isn’t always the best option anymore. Without taking risks, you can’t move your life forward. Loss aversion seems to be an ancient bias that hasn’t had the time to leave your mind yet.
Loss aversion in marketing
Loss aversion bias is targeted by marketers trying to influence your decision making.
don’t associate enough positive attributes to
a product to convince yourself to buy it.
A company may then offer a free trial. Some even offer you other free stuff you can only keep if you continue paying monthly.
Often, the pain of losing access to a product is greater than your motivation to acquire it initially. This results in you purchasing the product anyway, whether or not you need it.
There are also other ways that marketers target the loss aversion bias. For example, they may automatically opt-in to extras that you then have to opt out of yourself. This makes it clear you’re losing out on specific perks or extras.
In copywriting, writers often write in a way that indicates that you already own a product. They write in a way that gives you the feeling of already owning a product before you’ve even bought it.
Not buying it then means you’re losing out!
Loss aversion in daily life
In daily life, it’s hard to give examples that are 100% scientific, since there are so many variables. We can, however, look at some of the possible implications this cognitive bias can have based around clinical experiments. You can judge for yourself whether loss aversion has something to do with it or not.
One great example of where loss aversion effects your daily life is at work. Most people spend more time not getting fired, than actively reaching for a promotion. Losing their job is a bigger fear than growing career-wise is a reward.
This would also explain why more people don’t take risks.
Imagine how much better your life would be if you took a little more risk. If you talked to more people even though it isn’t “socially acceptable” or started working part-time to pursue your dreams.
Risk aversion would explain why most people don’t
live their life to the full.
What do you think would happen if you changed your frame of reference, from losing what you have to losing the opportunity you are presented with?
Framing your situations in a different way is a common practice in NLP (neuro-linguistic programming). Self-development gurus like Tony Robbins are always going on about framing your pain/losses differently.
There are many ways that loss aversion impacts your
life. These were just a few examples. To go over all examples, we’d be here all
Dealing with loss aversion bias
This is all well and good, but this information doesn’t help you to deal with loss aversion bias. It will, however, help to improve your awareness.
Cognitive biases cannot be eradicated completely. Heuristics and biases are what makes us so effective as a thinking being. If we were to ponder on everything to make a logical decision, we wouldn’t be able to get anything done.
We’d spend hours thinking about what we should eat
and getting dressed would be a nightmare!
Learning how loss aversion impacts your life, and how you respond during these scenarios, can help you loosen the grip this bias has on you.
Self-awareness makes it possible for you to catch yourself in the act.
If you get good at this, you’ll even be able to use some mental gymnastics and framing to get yourself to take actions on your goals. This makes it possible for you to use loss aversion bias in your favor!
Theoretically, by altering your subjective reality, you can convince yourself you are losing out on something by NOT grabbing every opportunity.
There are a lot of self-development programs that use framing and priming to change your beliefs. Do it right and loss aversion becomes a tool instead of a burden.
By noticing when the world is trying to influence you with loss aversion, you can prevent yourself from falling for this trap. Taking it one step further, you can potentially use this cognitive bias in your favor.
By using a bias to increase the likelihood of you making a choice you can influence yourself.
We’ll do another post on using loss aversion as a tool for self-development in the future.
How do casinos overcome loss aversion?
This is a question that came up while writing this post. In this YouTube video, you see people turn down bets that are highly in their favor, out of fear of losing something they possess.
Research has shown that it often takes a gain-to-loss ratio of 2:1 before people take a bet.
do casinos get people to keep tossing money into
Obviously, as people lose money, they want to make it back. This is where loss aversion turns into an issue that can have major consequences.
However, how do casinos get people to opt-in to playing a game that favors the casino, while your average person needs a 100% gain potential to risk their money in a bet with 50% odds?
Not only does the casino not offer 50/50 odds, but they also don’t offer the right ratio between odds and reward potential.
Unfortunately, I could not find any research that explained this. If you do, please shoot me a message or leave a comment so I can add it to the article!
Some theories I could come up with were:
– They give people extra value in the form of a nice location, food and drinks, and entertaining games.
– People often go to the casino with a set amount they will play and therefore don’t see it as a loss. Unlike scenarios in the normal world where they’re randomly thrown upon you, we plan most trips to the casino.
– Because the casino offers various games and different returns (ie, betting on red in roulette offers the possibility of a 2x payout, while going for a number offers a much higher payout)
– People have the possibility to bet multiple times, which reduces their perceived risk
Whatever the reason is, it’s an interesting thing to research!
As you can see, loss aversion is an important cognitive bias that impacts our daily life. It can cloud our judgment and even cause great financial and personal loss. However, without it, we wouldn’t be where we are today.
By noticing ourselves and our reaction in the face of losses, we can take back a little more control of our lives.
How are you going to work on your self-awareness?
Thinking fast and slow, by Daniel Kahneman https://en.wikipedia.org/wiki/Thinking,_Fast_and_Slow
Positive effect from losses on performance:
Gambling and loss averison https://open.library.ubc.ca/cIRcle/collections/ubctheses/24/items/1.0371930
Framing and perception’s effect on loss averions:
The body’s response to loss aversion: https://onlinelibrary.wiley.com/doi/abs/10.1002/bdm.692