What is Loss Aversion?
Loss aversion is a behavioural phenomenon that was first developed by psychologists Amos Tversky and Daniel Kahneman. It describes the tendency of individuals to experience the pain of losing more intensely than the pleasure of winning or gaining. It is a powerful driving force behind human decision-making, influencing everything from personal finance to sports performance. When faced with a choice between two options, people will often choose the one that minimises their potential losses, even if it means giving up the opportunity to gain more.
Why Does it Happen?
Brain function. Neuroscientists can point to medical evidence from actual scans, that will show heightened activity in certain parts of the brain, when we face a ‘loss situation’. Some of the activity comes from the same part of the brain that processes disgust and fear. The three main areas of brain that show this heightened activity are the amygdala, striatum and insula.
Do People Anticipate Loss Aversion?
In many cases, people may not even be aware that they are experiencing loss aversion. The tendency to avoid loss is deeply ingrained in human nature and it can be difficult to recognise when it is influencing our decisions. However, by being mindful of our thought processes and emotions, we can become more aware of our biases and make more informed choices.
Examples of Loss Aversion
Here are three examples of loss aversion in action:
- An individual chooses a lower-paying job with greater job security over a higher-paying job with less security.
- A person opts for a lower-risk investment with a lower potential return over a higher-risk investment with a higher potential return.
- A consumer continues to buy a brand they are unhappy with because they fear the pain of switching to a new brand that may not meet their expectations.
Can You Stop Loss Aversion?
One way to overcome loss aversion is to reframe the way we think about loss. Instead of viewing it as a negative experience, we can focus on the potential gains that come with taking risks. Another strategy is to make decisions based on logic and rational thinking rather than emotions. This means weighing up the potential risks and rewards of each option and choosing the one that offers the greatest overall benefit.
Loss Aversion in Betting and Gambling
A gambler puts down a £100 bet in a casino and loses. In most cases will they stop playing? Or will they continue to play? The answer is that they will continue to play. If you needed more proof, just look at Las Vegas, that continues to thrive largely because people find it so hard to ‘walk away’. The human brain hates pain; physical pain, emotional pain and, of course, the pain of losing.
Gamblers will often keep playing, even after losing significant amounts of money. This is because they are experiencing loss aversion and are trying recoup some of their losses to avoid the pain of losing. It’s the same for sports bettors.
I am now a seasoned, disciplined sports bettor and trader, but I haven’t always been. I had to train myself not to ‘chase bets’ or make the wrong choices in the midst of losing runs.
It is important for sports bettors to be aware of this bias and to make decisions based on logic and reason rather than emotion.
Kahneman and Tversky and a study based on certain gambles and asked people to react to them. I’ll ask you the same questions now that they asked of their test subjects.
Imagine that you have been given £1000. You now have a choice.
- Take a bet or gamble where you have a 50% chance to win another £1000. (Naturally, you risk losing the £1000 that you already have).
- Definitively win £500. (You would add this to the £1000 that you already have).
What would you do?
In the study, 84% of people chose the certainty of the £500 win.
Now imagine that you have been given £2000. You now have this choice.
- Take a gamble where there is a 50% chance of losing £1,000. (Half the money you have been given).
- Definitely lose £500.
What would you do?
In the study only 31% of people chose the certainty of the £500 loss.
This highlights the loss aversion issue. In both examples you have the same expected outcomes but the first example is framed in a ‘positive’ way – you gain. The second example is framed in a ‘negative’ way – you lose.
Individuals are willing to take on risk to avoid a loss but they’re not as likely to take on risk for gain.
Overall, we are roughly 2.5 times more sensitive to losses than the equivalent gains.
Sunk Cost Fallacy
Another issue facing gamblers is ‘Sunk Cost Fallacy’, first considered by Richard Thaler. He realised that people are generally unwilling to give up on something when they have already invested in it, in terms of time, effort or money.
A simple example of this might be not giving up on an event you are watching, even if you are not really enjoying it. You’ve already paid and you feel it’s a waste not to see it through.
Think of a slot machine. The pour in the coins, time, effort (to a degree) money. You want that payout, you don’t want to give up.
Generally, we don’t want to accept that we might have made the wrong decisions.
Loss Aversion and Sports
Professional athletes (like most people) hate to lose. However, athletes often perform better when they are trying to ‘avoid being beaten’ rather than simply ‘trying to win’. So their performance can often improve when they are e.g. a set down in a tennis match, when compared to an ‘all square’ situation at the beginning of the match. As soon as a situation is identified as ‘losing’ by the brain, athletes will up their performance to avoid it all cost.
Over a five year period the early 2000’s, Devin Pope and Maurice Schweitzer analysed over 2.5m putts from the PGA Tour. They specifically looked at putts for par compared to attempts for birdies. Around 83% of putts for par were successful. Only around 28% of birdies were successful.
Naturally, many of the birdie putts would have been from longer distances, but even when this was taken into consideration, 3.7% more shots for par were successful, than for birdies.
The researchers put it down to loss aversion. Although in both situations, if the putt is missed, the player goes one shot over, sinking a birdie (going one shot under) is always thought of as a ‘gain’. A bogey will always be seen as a ‘loss’ (going one shot over). A putt for par is an obvious potential losing situation that the golfer wishes to avoid.
Another interesting point relating to golf is that when birdie putts are missed, they usually miss short, still putting the golfer in a reasonable position to make the next putt. Being too aggressive, means that the player might hit too long, putting him in a worse position.
Tennis exposes loss aversion in athletes, perhaps more than any other sport. Every time a player needs a second serve, it is almost without exception, a slower serve. They do this to avoid risking a double fault and subsequently losing the point.
Around 65% of first serves are successful and 75% of those points are won by the server. For second serves it’s quite different, with 50% of points won by the server. So, the win percentage for a fast first serve and a slow second serve is 64.5%, but if a player were to adopt two fast serves, the win percentage would be 65.8%.
|Win % Fast 1st, Slow 2nd||64.6%|
|1st Serve Win||1st Serve In||1st Serve In & Won|
|2nd Serve Win||2nd Service In||2nd Service In & Won|
|Win % Fast 1st, Fast 2nd||65.82%|
|1st Serve Win||1st Serve In||1st Serve In & Won|
|2nd Serve Win||2nd Serve Won||2nd Serve In & Won|
This loss aversion, reduces the players’ chances of winning their service points.
To switch to a ‘two fast serve’ strategy, however, would require some mental toughness. Players would be double-faulting a lot more and this could of course affect the rest of their game beyond the serve.
When football teams go ahead in games, they often become more defensive. Say a team is 3-0 up at half-time, very often they will sit back in the second half and let the other team attack them, taking a ‘come on have a go then’ attitude. The leading team always has the option of hitting their opponents on the break. There is no need for the leading team to attack excessively and expose themselves to ‘loss’ by potentially conceding a goal that could change the game.
When a team is e.g. 3-0 up at half time, more often than you think, the match finishes 3-0, or perhaps only one more goal is scored during the second half. This of course depends on each individual game situation (two-legged ties and so on) and the nature of the teams involved.
In a way, this sudden defensive mindset goes against common sense. The team leading 3-0 have tactics that have obviously been working. They are changing a winning strategy, despite it being a successful one. However, one has to remember that although goal difference counts, by the main marker of league points, teams still only get three points for the win, irrespective of how many goals they score.
Tactical changes like this are linked to a heuristic called endowment theory. People or teams, are likely to hang on to their position more strongly when they have already gained something. When a football team scores a goal (or are endowed with a goal) they review the match based on the new game situation.
A team with a 1-0 advantage, will generally have less desire to score another goal. This is because a 2-0 win is only slightly more beneficial (goal difference) than a 1-0 win. Yet both scores are a lot better than a draw.
How Companies use Loss Aversion
Companies are constantly using loss aversion in their marketing to consumers. One area which is readily exploited is the sale of extended warranties on appliances and electrical goods. Most extended warranties are extremely bad value, yet the customer, having purchased their new product, is vulnerable to the thinking that it might break down. They are still willing to pay for an expensive extended warranty so that they can avoid loss in the event that their newly purchased product becomes faulty.
People are willing to go to great lengths to protect themselves from the unbearable feeling of loss.
Other Marketing Techniques
- Ownership Effect: People like to keep what they already own, including digital products or services. Subscription services that offer better value for longer periods.
- Reframing: Information presentation.
“Buy today and get 50% off” – Start countdown timer. Or “98% Fat Free” as opposed to “2% Fat”
- Free Trials: After a successful free trial period, customers don’t want to miss out, extending their subscriptions.
- Scarcity: “Don’t miss out, limited stock available.” Companies instil a sense of fear of loss in the consumer.
- Limited-Time Offers: “This offer is available for this weekend only.”
- Loss Aversion Nudge: A gym might offer a reduced membership rate for customers who attend a greater number of classes per month. This encourages people to attend more classes to avoid the losing their discounted rate.
Loss Aversion is Not a Bad Thing
From an evolutionary perspective, aversion to loss was most likely a good thing. Take the longer route, or live in a less fertile place, to avoid being eaten! Also, countries, governments, and corporations need to act responsibly in the face of difficult social and economic challenges.
Loss aversion brings about the likelihood that people will do more to avoid losses, than to achieve the equivalent gain. The brain perceives losses as psychologically more painfull and we are wired to avoid this if possible. Although loss aversion is not necessarily a bad thing, it often prevents us from achieving a better ‘net overall gain’ in life.