What is Loss Aversion?

A video explaining Loss Aversion Bias by Rolf Dobelli the author of The Art of Thinking Clearly on the IDFC Mutual Fund Youtube Channel.

WHAT IS LOSS AVERSION AND WHY EVIL STRIKES HARDER THAN GOOD

On a scale of 1 to 10, how good do you feel today? Now consider what would bring you up to a perfect 10. That vacation in the Caribbean you’ve always dreamed of? A step up the career ladder maybe? Next question: what would make you drop down by the same number of points? Paralysis, Alzheimer’s, cancer, depression, war, hunger, torture, financial ruin, damage to your reputation, losing your best friend, your children getting kidnapped, blindness, death? The long list of possibilities makes us realise just how many obstacles to happiness exist; in short, there are more bad things than good – and they are far more consequential.

In our evolutionary past, this was even more the case. One stupid mistake and you were dead. Everything could lead to your rapid departure from the game of life – carelessness on the hunt, an inflamed tendon, exclusion from the group and so on. People who were reckless or gung-ho died before they could pass their genes on to the next generation. Those who remained, the cautious, survived. We are their descendants.

So, no wonder we fear loss more than we value gain. Losing $100 costs you a greater amount of happiness than the delight you would feel if I gave you $100. In fact, it has been proven that, emotionally, a loss ‘weighs’ about twice that of a similar gain. Social scientists call this loss aversion.

For this reason, if you want to convince someone about something, don’t focus on the advantages; instead highlight how it helps them dodge the disadvantages. Here is an example from a campaign promoting breast self-examination (BSE): two different leaflets were handed out to women. Pamphlet A urged: ‘Research shows that women who do BSE have an increased chance of finding a tumour in the early, more treatable state of the disease.’ Pamphlet B said: ‘Research shows that women who do not do BSE have a decreased chance of finding a tumour in the early, more treatable state of the disease.’ The study revealed that pamphlet B (written in a ‘loss-frame’) generated significantly more awareness and BSE behaviour than pamphlet A (written in a ‘gain-frame’).

The fear of losing something motivates people more than the prospect of gaining something of equal value. Suppose your business is home insulation. The most effective way of encouraging customers to purchase your product is to tell them how much money they are losing without insulation – as opposed to how much money they would save with it, even though the amount is exactly the same.

This type of aversion is also found on the stock market, where investors tend to simply ignore losses on paper. After all, an unrealised loss isn’t as painful as a realised one. So they sit on the stock, even if the chance of recovery is small and the probability of further decline is large. I once met a man, a multimillionaire, who was terribly upset because he had lost a $100 bill. What a waste of emotion! I pointed out that the value of his portfolio fluctuated by at least $100 every second.

Management gurus push employees in large companies to be bolder and more entrepreneurial. The reality is: employees tend to be risk-averse. From their perspective, this aversion makes perfect sense: why risk something that brings them, at best, a nice bonus, and at worst, a pink slip? The downside is larger than the upside. In almost all companies and situations, safeguarding your career trumps any potential reward. So, if you’ve been scratching your head about the lack of risk-taking among your employees, you now know why. (However, if employees do take big risks, it is often when they can hide behind group decisions.)

We can’t fight it: evil is more powerful and more plentiful than good. We are more sensitive to negative than to positive things. On the street, scary faces stand out more than smiling ones. We remember bad behaviour longer than good – except, of course, when it comes to ourselves.

Next:
Social Loafing – WHY TEAMS ARE LAZY

Similar Biases:
House-Money Effect – WHY MONEY IS NOT NAKED
Endowment Effect – DON’T CLING TO THINGS
Social Loafing – WHY TEAMS ARE LAZY
Default Effect – WHY YOU GO WITH THE STATUS QUO
Sunk Cost Fallacy – WHY YOU SHOULD FORGET THE PAST
Framing – IT’S NOT WHAT YOU SAY, BUT HOW YOU SAY IT
Affect Heuristic – WHY YOU ARE A SLAVE TO YOUR EMOTIONS

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Induction – HOW TO RELIEVE PEOPLE OF THEIR MILLIONS

The above article is from the book The Art of Thinking Clearly by Rolf Dobelli. The article is only for educational and informative purposes to explain and understand cognitive biases. It is a great book, definitely worth a read!