What Is Loss Aversion And How To Avoid This Bias

What Is Loss Aversion And How To Avoid This Bias


Have you been feeling particularly cautious lately? Do you find yourself avoiding making major or seemingly risky decisions until you feel life has returned to “normal”? This isn’t unusual, and you are not alone. In these uncertain times of the COVID-19 pandemic, people would rather stick with what they perceive as safe. They veer away from making any sudden changes that could rock the boat and resort to loss aversion instead.

After more than a year of having to take drastic measures to secure our safety as well as those of our loved ones, it’s not surprising to find that some people would choose to hunker down even when faced with issues that don’t pose any mortal danger to them.

The pandemic has challenged us to become more resilient—a good thing—and even pick up an additional useful skill or two. However, the flip side presents us with a potentially unfortunate side effect—that it could have altered our risk-taking behavior.

Read on to learn what loss aversion is and how you can avoid this bias.

Taking Risks, Making a Change

Why is it important to have a healthy view of risk? Shouldn’t we approach life with caution to avoid making mistakes?

I would say that, indeed, making careful, decisive choices will yield great results, so long as you can identify the line between being reasonably cautious and being downright fearful. There are also certain patterns in decision-making that you must watch out for.

To illustrate further, I present you with this example: Let’s say you meet a kind stranger who offers you your choice of a great deal with absolutely no tricks. He gives you $45. Then, he asks you if you want to hold on to the money or give it back to him in exchange for a coin flip. If it’s heads, he’ll give you $100 right then and there. If it’s tails, you get nothing.

So, which one do you choose? Instant cash in your pocket or a chance to flip the coin? Think hard before you read further.

When I present this coin scenario to different audiences, about 80% say they’ll take the $45 from the stranger. That’s the choice I made when I was also presented with this scenario many years ago. The same can be said for most people in studies of similar choices. And why not? The $45 is a sure thing, after all.

Back then, I thought that I’d certainly feel foolish if I took the risk just for a shot at getting $100 only to lose out. My gut instinct told me to avoid losing. I suppose anyone would feel the same way initially.

Here’s the thing, though. If we run the numbers, the chance of getting heads is 50%, so in half of all cases, you’ll get the $100. In the rest of the cases, you won’t get anything. So, that’s equal to $50 on average, compared with just $45.

Now, imagine if you flipped the coin 10 times, then 100 times, 1,000 times, on to 10,000 times, and then 100,000 times. At 100,000 times, on average you would win $5 million if you picked the coin flip for $100 every time, compared with $4.5 million if you picked $45 each time. The difference is an amazing $500,000.

This means that picking $45 as your gift from the stranger leads to you losing out. The correct choice—the one that will mostly not lead to you losing—is to pick the coin flip. Pick the other choice and you’re pretty much guaranteed to lose over multiple coin flips.

However, you might reason out that I presented the scenario as a one-time deal and not as a repeating opportunity. Perhaps, you’d say that if you knew it was a repeating scenario, then you would have picked differently.

The problem lies with this: studies have shown that our gut addresses each scenario we face as a one-off. In reality, we are presented with a multitude of such choices every day. We are goaded by our intuition to deal with each one as an isolated situation. However, these choices are part of a broader repeating pattern where our gut pushes us towards losing money. We avoid risks—fearful of losing—and end up losing in the end.

Why Are People Afraid to Take Risks?

We are prone to shying away from risks due to a mental blindspot called loss aversion. This is one of the many dangerous judgment errors that result from how our brains are wired—what scholars in cognitive neuroscience and behavioral economics call cognitive biases.

Research has shown that people are more sensitive to possible losses than potential gains.

Loss aversion goads us into having an unhealthy view of risk, causing us to have a knee-jerk and one-size-fits-all approach to risk-taking, which is to outright reject it. This rejection runs counter to the resilience and flexibility we gained during these uncertain times. It also poses a threat to how we can continue to adapt to the shifting nature of this pandemic, as well as how to smoothly transition to a post-COVID life.

The Sweeping Influence of Loss Aversion

It’s easy enough to think that loss aversion only comes into play during major decisions or turning points. However, we are presented with a multitude of similar choices daily that—much like in the coin-flip scenario—represent a broader pattern that could cause us to lose out in life.

Remember that loss aversion isn’t just limited to decisions that have a corresponding monetary result. It also applies to situations and circumstances where avoiding a possibly negative outcome might blind you to potentially positive changes in your life.

Here are some aspects of life that can easily be derailed by loss aversion.

1. Exiting Toxic Relationships

Have you ever stayed in a relationship (romantic or otherwise) that has clearly already run its course? Perhaps this relationship already causes you distress or keeps you from reaching your personal goals.

Yet, despite indications that you would have a healthier, happier life without this stressful relationship, you find it difficult to walk away because of the disruption it would cause in your life. You worry about the loss of your routine, and this holds you back.

2. Making Much-Needed Career Changes

People are particularly cautious about making career changes especially during this pandemic, opting to “wait it out” and just trudging on until life returns to “normal.”

We need to remember that we may never get back the version of normal that we had pre-pandemic. Just as the world changed and readjusted to COVID, so did each individual, and so did employers.

Jobs and employment are constantly shifting and evolving, more so now than before, so you have to weigh and consider if the loss of an old job is truly that daunting versus transitioning to a new career that could enrich your life mid- and post-pandemic.

3. Dealing With Your Current Pandemic Life and Looking Forward

Loss aversion can trickle down even to the smallest perceivable things in life. With our wariness of COVID-19 modifying our behavior when it comes to going out, physical distancing, and socializing, it’s perfectly understandable to someday come out of this pandemic more cautious, more health-conscious, and more aware of our security than we were before 2020.

However, as we start to consider what the world will be like after the pandemic, we should also plan our lives accordingly. This means that while our social and networking circles were forcibly shrunk in the last year, there is no need to let our lives deliberately stagnate for fear of leaving our comfort zone.

It also means that, when the time is right, we must be willing to reintegrate our lives into a changed world and balance the risk with a potentially more meaningful life.

Conclusion

While it might seem daunting, looking ahead into the future calls for a reexamination of loss aversion. If left unchecked, it will keep you from living your best life as it goads you into focusing on what you could lose versus what you might gain.

With or without the pandemic, viewing risk with a steady perspective can indeed be helpful when weighing how to proceed with major life decisions. However, focusing too much on the risk may lead to abject fear, which can keep you from making balanced, decisive choices.

Identifying the repeated pattern of our choices and knowing how to tackle and transform each possible loss into a gain will go a long way in winning in life—with or without a pandemic.

More Biases That Unconsiously Affect Us Every Day

Featured photo credit: AJ Yorio via unsplash.com



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