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We fear losing what we have.

Defeat

Ever heard of the term - "playing not to lose?" When the stakes get higher, we find that players/teams tend to become more conservative and try to avoid mistakes. For example, in the latter stages and the players are worried they might lose their grasp on it.

Welcome to the world of loss aversion. Put simply, in our brains, the pain of losing something is psychologically more powerful than the pleasure of gaining the same exact thing. Here are some of a long list of examples*:

 

  • People are likely to stay watching a movie they really dislike, instead of leaving the cinema. We are afraid of "losing" the value of the ticket we have already paid for, instead of the "gain" of time which we could do something else that we would enjoy more. This is what we call "Sunk Cost Fallacy", and it also applies to the reluctance to sell stock and property which are declining in value. 

  • Most of us prefer a small certain reward (e.g. 100% of getting $1) than an uncertain large reward (10% chance of getting $100) - even though the uncertain large reward has a larger expected value.

  • Flip a coin - heads you win and tails you lose. There's exactly a 50-50 chance in this game. Rationally, you should be want to play the game as long as the reward for winning is even slightly larger than the cost of losing. But people were only willing to play this game is the amount you stand to win is a minimum of 150-250% the amount you stand to lose. 

  • Which method would help to decrease the use of plastic bags more? Offering a $0.05 bonus if someone doesn't take a plastic bag, or charging $0.05 when someone does? You guessed it - there was no change in behaviour when the $0.05 reward is offered; when the $0.05 charge is imposed, plastic bag usage fell 42% (Homonoff, 2007). This is an important takeaway - when you are trying to get someone to do something, a penalty tends to be more effective than a reward. 

  • People are more willing to behave dishonestly (i.e. cheat) to avoid a loss than to make a gain (Schindler & Pfatteicher, 2016). 

* There has been a spate of recent research with findings that go against what loss aversion predicts. However, most of these research revolves around very small gains and losses. The bigger takeaway is not that loss aversion doesn't hold, but that it doesn't seem to apply for very small amounts (because the brain simply doesn't process it as a loss).

We have discussed in every one of our chapters on fear - that all fears originate to ensure our survival. It is easy to see why fear aversion was developed:

- you are alive right now

- what you currently have must be keeping you alive

- if you want to continue staying alive, you naturally don't want to lose anything that might have kept you alive. 

- conversely, gaining something new is great; but it is not necessary because you have been able to stay alive without this new thing.  
 

The pain from losing something you have is more than
the pleasure of gaining something new

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The Ostrich Effect

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We have this common impression of the Ostrich - when it feels scared or threatened, it buries its head into the ground, to avoid seeing what might happen next. The ostrich tries to hide from is problems, rather than face them. 

(The timid ostrich hiding from incoming problems is actually a myth by the way. If it actually did bury its head in the sand, the ostrich would quickly suffocate to death. What actually happens is, ostriches would dig shallow holes in the ground as nests for their eggs. Occasionally, the would look down into the nests, and use their beaks to check on and turn the eggs. Animals that continue to exist today after hundreds of thousands of years are far too well-primed for survival to foolishly hide just its head in the sand).

 

However, while it is a myth for the ostriches, the ostrich effect is a very accurate metaphor for human behaviour at times - when we try to hide away and hope that simply by denying the existence of a problem, the problem will go away.

There is an element of fear of loss behind this. 

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Karlsson, Loewenstein, & Seppi, “The Ostrich Effect: Selective Attention to Information,” Journal of Risk and Uncertainty 38, no. 2 (2009): 95–15.

Relax, the graph above is far less complicated than it looks.

  • The BLACK line above is the value of the S&P 500 on the stock market.

  • The GREY line is the number of logins by stock owners

  • For most of the chart above, we can see that the movement of the Black and Grey lines are tied to one another.

  • When the Black line (stock prices) rises, the grey line (logins) also increase; people are eager to login and check how much they have "earned".

  • When the Black line decreases, the grey line similarly trends downwards; people login less because of the fear of bad news, how much they have lost.  

  • Oct 2007- the sub-prime mortgage crisis started to emerge. The market (but for a temporary spike) starts trending downwards.

  • But notice what happens as the black line starts going down - the grey line, the number of logins, hit rock-bottom. Investors, worried about the crisis, stopped logging in; they choose to hide from the losses instead of taking action. 

  • In January 2008, the market falls more rapidly. 

  • We notice here that the 2 lines, black and grey, diverge significantly for the first time. Why?

  • The crisis got bad enough that people had no choice but to login to manage their stocks. Investors could no longer hide from their problems.

  • But imagine if the investors had taken action earlier. That instead of trying to escaping from the potential fear of loss, they had faced the problem when it emerged.

  • Would they not be better off?
     

Have you ever done the same?
Have you ever been so fearful of what you might lose,

that you didn't take action until it was too late?

Why is it so hard to make changes to our lives?

Loss aversion is one of the major contributing factors why it is so difficult to make changes to our lives. Say you want to go into a new line of work. Or to go on extended solo-travel. Or to adopt your first pet. It might appear that the fear comes from not knowing what the new experience will be like. But for many of us, there is also a fear of losing the current way of doing things that we've gotten familiar with and gotten quite good at. We fear losing familiarity. Read more about this in the case study - why is it so difficult for us to make changes in our lives?

A growing body of evidence suggests that entrepreneurs don’t like risk any more than the rest of us —and it’s the rare conclusion on which many economists, sociologists, and psychologists have actually come to agree. In one representative study of over eight hundred Americans, entrepreneurs and employed adults were asked to choose which of the following three ventures they would prefer to start: (a) One that made $5 million in profit with a 20 percent chance of success (b) One that made $2 million in profit with a 50 percent chance of success (c) One that made $1.25 million in profit with an 80 percent chance of success The entrepreneurs were significantly more likely to choose the last option, the safest one. This was true regardless of income, wealth, age, gender, entrepreneurial experience, marital status, education, household size, and expectations of how well other businesses would perform. “We find that entrepreneurs are significantly more risk-averse than the general population,” the authors conclude.

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