What Is Loss Aversion? (Plus How to Avoid It in 5 Steps)
By Indeed Editorial Team
Published 26 April 2022
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
Humans have a variety of cognitive biases that affect their decisions, and loss aversion is just one example. It's a concept that explains why people tend to prefer avoiding a potential loss instead of acquiring a potential gain. Understanding more about this phenomenon can help you minimise your own bias as much as possible so you can make better decisions and judgments during your career. In this article, we discuss what loss aversion is, how you can reduce it in five steps and offer a few tips to help you avoid it in your career.
What is loss aversion?
Loss aversion is a psychological phenomenon where an individual perceives a loss as more harmful than a gain of the same amount. This can result in the individual behaving irrationally and possibly taking on more risk than otherwise. Few people like to lose, but those who are loss-averse may choose to hold on to investments even after experiencing substantial losses. For some, the pain of potentially losing an investment is far more significant than the positive feelings of winning.
There are a few different levels of loss aversion, and some may be more averse than others. In some situations, losing something can feel twice as significant because people often value the things they own more highly. The fear of losing can cause investors to make adverse investment decisions. For example, an investor with stock in a company that's quickly losing money may decide to invest in another riskier company. Instead of simply pulling their money out of their original investment, they may have hopes of breaking even.
Loss aversion vs. risk aversion
While loss-averse individuals are more sensitive to losses than gains, risk-averse individuals are more susceptible to uncertain or risky consequences. Investors with this aversion tend to avoid risky investments altogether. Instead, they may opt for investments that don't experience much volatility. They're only likely to choose a riskier investment if compensation is guaranteed. In comparison, the loss-averse investor may select a riskier investment if they believe it can help avoid a loss.
How to reduce your aversion to loss
Loss aversion can significantly impact your decision-making and affect your potential to make good returns, no matter how small the loss is. While it isn't always possible to completely remove such cognitive biases, there are things you can do to cope with such losses and avoid becoming overly averse. Here are five steps you can take to reduce your aversion to loss:
1. Think about what you do have
The first step to overcoming your aversion is to think about all of the things you do have and how they benefit you. Practising gratitude isn't only an excellent way to accept what you have, but it's also a valuable way to eliminate your fear of losing it. Even if you do experience a loss, knowing that you've got plenty of other things in your life can be helpful.
It can be especially beneficial to keep a list of all of the things that are the most meaningful to you. Every day, consider adding one or two items to the list so you can get into the habit of checking the list and remembering what you have in your life more easily. Owning a gratitude journal can encourage you to be more grateful for the things around you.
2. Create a long-term plan
Creating a long-term plan involves examining what you have, what you want to have and how you can potentially get there. The more you think about the future, the less likely you're to worry about a short-term loss. First, you can write down what you want your life to look like in a few years. Try to be as concise and realistic as possible. This way, you can have something to work towards achieving. Next, you can write down your SMART goals. SMART goals are specific, measurable, attainable, relevant and time-bound.
After defining your goals, consider what you want your long-term strategy to be. Depending on these goals, you may have multiple strategies instead. Suppose you're planning to create your own business selling hats. In that case, you might have different strategies for purchasing equipment to sew on the designs and to market your new hat company to potential buyers. During the process, you may want to review or adjust your plan to achieve your goals too.
3. Make a list of potential scenarios
Thinking about the various possibilities and writing them down can help you become more aware of the potential for losses and less averse in the process. Focusing on the potential for adversity can help you become more aware of the steps to take if something happens.
While it isn't necessary to think about every possible outcome, it's still helpful to consider some of the possibilities and how they can affect you. Thinking about how you might react in each situation can also help. Instead of focusing on the difficulty of a loss, ponder about how you plan to overcome the loss. It may also help to rank the scenarios based on the worst possible outcome to the least bad.
4. Address how you consume information
After actively thinking about the potential losses you might face and rationalising those losses, consider reducing your information consumption. Social media and mass media often exploit the public's aversion by reporting sudden losses in financial exchanges. On days when stocks are doing good, you're unlikely to hear about it nearly as much.
Try to reduce the amount of time you spend online as much as possible. Instead, focus on reading a book, cleaning the house or engaging in a hobby. When you look at the news, try to look for stories that are positive rather than negative.
5. Seek out the perspectives of others
Reading books on the experiences of people overcoming their losses is a great way to reduce your aversion because it becomes easier to envision yourself doing the same. Learning about the risks that others have made before meeting their own goals has the potential to increase your confidence. Many well-known figures have written autobiographies, including their unique methods of overcoming aversion to losses.
Why reduce your aversion to loss?
Being loss-averse can negatively affect decision-making and prevent you from making logical decisions. Investors who fear a loss often avoid selling their funds and incur a more significant loss over time. In the real estate industry, investors usually keep their property and end up paying the interest on their loans, costing them even more money.
This aversion can also impact innovation. Companies often have limited resources to spend on new projects. When a project isn't as profitable as the company would like, they sometimes miss out on an opportunity by ending the project prematurely to avoid a loss.
Tips for avoiding loss aversion
Here are a few tips to help you avoid loss aversion, regardless of the circumstances:
Focus on the net impact
Instead of thinking about an individual loss, think about your project or portfolio in its entirety. If you succeed in some aspects, even when others incur a loss, the impact is still positive. Focusing on it as a whole is also an excellent way to avoid spending too much time trying to predict where the subsequent loss might be. Altering your perspective by concentrating on your overall position instead of a single piece of data can make you less loss-averse.
Learn more about aversion and other biases
Understanding why aversion to loss occurs may help you avoid it more easily. Certain individuals may be more susceptible to psychological effects than others. Understanding these effects and how they might affect you can make you more aware of your subconscious thoughts, processes and judgments. When you're about to make a decision that may involve a loss, stop and consciously think about it. You can even set yourself some time aside to make a decision. Taking just a few minutes may make a big difference.
Reward yourself when you experience gains
Another helpful way to counteract a loss is by consciously rewarding yourself when you experience returns. This way, you can avoid experiencing negative feelings from a short-term loss and concentrate entirely on your positive gains. You may reward yourself with a fun trip or a special purchase once you meet your goal, so you have something to anticipate.
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