Loss Aversion Bias

Loss Aversion Bias

Time for Reflection

How do you approach decision-making for situations/ events which provide equal potential for moving forward as for going backward ? 

• Do you keep an eye on the advantages/ benefits that the situations/ event has to offer ? 

OR 

• Do you adopt a risk-averse approach and in such a situation and focus more on minimizing loss than on maximizing gain ? 

Here's another one - 

Which of the following deal/ offers do you find more attractive ?

• a deal offering 20% flat discount on your favourite product

OR 

• a deal offering 15% discount but additionally building exclusivity by suggesting you to hurry up and not lose out this unique opportunity to own a piece of your favourite product before the stocks run out !

If you are the one who prefers a "play safe" option, even when it is at the cost of growth, you are bound to select an approach which involves less risk and which focuses more on the aspect of loss.  Even in retrospect, while you recall addressing some key events of your life, maybe an important investment or taking a call on the relationship front or about a new assignment/ job, the one common thing in your approach across each of them(event) must have been the tendency to try to "avoid losses". These losses could be of any nature, such as financial, materialistic, emotional, time-based, etc. This tendency of  "avoiding losses" is an indication of the presence of a bias, known as "Loss Aversion". 

Let's look at this bias in more detail 

Definition and Background

"Loss Aversion" is defined as the tendency of the people to prefer avoiding losses than acquiring equivalent gains. When confronted with a scenario/ event, providing equal potential for loss and gain, we tend to select a "loss avoiding" option always, when impacted with this bias.  

Loss Aversion is an important concept in the field of Behavioral Finance and holds the key to successful investment. The more the anticipated loss, the more we tend to hold onto that investment.

In 1979, psychologists Amos Tversky and Daniel Kahneman developed a successful behavioural model, called prospect theory, using the principles of loss aversion, to explain how people assess uncertainty. The experiments carried out also showed that in people, the pain of losing is psychologically about twice as strong as the pleasure of gaining and therefore a human tendency to focus more on avoiding loss.

Why/ How Does Loss Aversion Bias occur?

Loss Aversion Bias occurs

• because of our innate need/ desire to avoid losses than to achieve gains. 
• We, humans, are afraid or losing and want to avoid the psychological pain associated with losing/ mission out 
• because of our(human's) basic instinct for survival, our natural response is always more towards addressing threats than opportunities.

Indicators/ Symptoms of Loss Aversion Bias

• Avoiding changing the "status-quo"
• Focusing solely on the "loss" aspect
• Having tendency to delay things and putting timely closure on them
• Hanging on to things till they result in psychological, emotional pain
• Delay in letting go of things that are not providing desired results 

Impact of Loss Aversion Bias

The bias has an impact, both at the individual and organisational level

Of the many negative impact of the bias, few of the key ones are  

• Develop the habit of procrastination
• Adversely impacts rational decision making
• Makes us vulnerable about our possessions. The more we have, the more vulnerable we become
• Builds a pessimistic and defensive approach towards life where avoidance becomes the mantra 
• Limits growth and development because of preference to stay in "comfort zone"
• Results in bigger losses than necessary as the tendency is to hold on till the "closure"
• Results in stress as the losses add up 

At the organisational level, the bias could lead to huge financial losses and may even lead to bankruptcy. 

On the flip side, i.e. on a positive note, this bias helps us be more cautious in life, avoid taking risks, develops patience

Real-Life Examples of Loss Aversion Bias

This bias is used to great effect in many areas of our life, both at an individual level and organisational level. Some examples are  

• Consumerism, where it is used to trigger impulsive buying through strategies like
• End of Season Sale
• Stock clearance (only few items left)

• Human Resource, in areas like 
• Employee Motivation, where, still, "carrot and stick" approach is used as a strategy for employee motivation
• Recruitment, where, a better pitch to the candidate would revolve more around what they would lose out by not being a part of the organisation than what additionally they can hope to gain over their present assignment 

• Decision-making  at an individual level, where the "odds in favour" are the same as "odd against". It could be
• Making an investment decision, whether to stick to existing investment, which has started showing signs of downward spiraling or to opt for a new investment
• Making a decision about moving out of an existing relationship which is in troubled waters

Overcoming/ Addressing Loss Aversion Bias 

• Using a framework for decision-making to ensure that all the associated parameters related to the context are captured  
• Goal-setting would help create SMART goals resulting in being focused on what needs to be aimed at and by when relevant actions to be taken and desired results to be achieved. This would help pay attention to possible gains instead of loss
• Develop the habit of seeing the Big Picture to ensure clarity about the vision
• Be open to Fail, Learn and Move on. It's not always that we may get every thing right 
• Emotional detachment from the event to ensure a more rational decision making process
• Developing a mindset/ attitude of Abundance rather than of Safety
• Perspective Changing is a good strategy to quantify the risk to a more relatable unit for comparison 

"Avoiding Loss" does not equate to "Embracing Gain" !