Loss aversion bias is a mental bias that causes people to make wrong decisions to avoid losses. Because the pain from losses is more powerful than the joy from gains.
Let’s say you want to flip a coin with your friend.
You offer him $300 if he wins the toss and ask for $200 if he loses.
It’s a good decision for him to take the bet — the expected value is positive.
But he’d likely reject it.
Because the pain from losses is almost two times more powerful than the joy from the gains. And this is called loss aversion.
It’s a strong bias that shapes our decisions without us knowing.
And the higher the stakes, the stronger the loss aversion gets.
Loss aversion bias examples in real life
- People stick with jobs they hate. Because they fear the loss of status and stability. Even when they have the potential to earn more doing something else
- People tend to overvalue what they own. Because they relate selling with losing (the endowment effect). So yes, Tyler Durden was right. The things you own end up owning you
- Investors sell their winning positions but keep the losing ones forever. Because they don’t want to realize the loss
- People try to cover their mistakes even when it’s inadvertent. Because they fear the loss of credibility. The audit firm Arthur Andersen that caused the Enron Scandal was not convicted of securities fraud — but of shredding tons of documents to cover up its errors and avoid potential fines
- Organizations resist change. Because the potential losers of the change are always louder than the potential winners
Three tips to overcome loss aversion bias
1. Imagine the worst-case scenario
We are loss averse; because our 300,000-year-old brains are programmed to keep us alive.
But most modern life decisions don’t have any survival risk.
So when you need to make an important decision, think of the worst-case scenario.
Is that really bad?
Sometimes it is — like the Arthur Andersen executives’ decision to cover up errors instead of admitting the mistakes.
But in most cases, you’ll realize the downside is lower than expected.
Loss aversion is holding you back.
Plus, most decisions are reversible anyway.
Realizing this will give you the courage to take calculated risks and minimize regrets for your future self.
2. Think in bets
To overcome loss aversion bias, take each decision as a bet.
Calculate the expected value. And make decisions like a poker player.
Yes, in real life odds are more complex than a coin toss.
But you don’t need to know the exact probabilities. An estimate should be enough to show you if the bet is worth the risk.
3. Reframe the potential loss
Every great entrepreneur has failed business ventures.
Every legendary investor has terrible investments.
Losses are normal in the game.
But their optimism before making decisions eventually brings them success.
So frame your decisions to emphasize the upside potential. Remember the framing effect.
A positive frame will make you more open to taking risks.
Yes, always cover your downside. Avoid ruin.
But never let loss aversion make you fail before you even try.
“If you don’t bet, you can’t win. If you lose all your chips, you can’t bet.”
Larry Hite
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References:
Daniel Kahneman & Amos Tversky (1977). Prospect Theory. An Analysis of Decision-Making