Understanding Loss Aversion

Effectively Using the Fear of Losing.

Nobody likes to lose. But here's an interesting find from the field of behavioral economics: We hate losing twice as much as we love winning.

This principle of "loss aversion" creates some interesting opportunities for change, which I hinted to in my last post. I asked the question, how does loss aversion keep us from changing? And how can we use the principle of loss aversion to accelerate change and growth? As promised, here are some answers.

First, let's do a quick refresh on the loss aversion idea. Loss aversion is a basic human tendency to prefer avoiding losses to acquiring gains. Researchers have shown that the misery we feel when losing something is twice as great as the happiness we feel in gaining the same thing. If you lose a hundred dollar bill, you'll feel twice as bad as getting the hundred felt good.

Loss aversion keeps us from changing, because all change involves some kind of loss. I can only travel south if I'm willing to lose out on north. Every time I travel east, I lose out on west. Every choice for change is a decision to lose something, because there's some sort of payoff in everything we do.

Whenever we resolve to change, we run square into the brick-wall resistance of loss aversion. If we stop eating Big Macs with supersized fries and Coca-Cola, we lose the immediate pleasure of great taste. That's misery. If we stop smoking, we lose a pleasure that soothes our nerves and keeps us trim. More misery. If we start working out in the morning, we miss out on some pretty appealing rest. Misery again. Loss aversion keeps us circling in holding patterns of behavior, even if that behavior is destructive in the long run.

So how do we get loss aversion working for change instead of against it? Simply create a way to lose by staying the same. In other words, put something at risk. Put your money on the line. Put your reputation on the line. Figure out a way to make the fear of losing part of your incentive to change.

Accountability partnerships do this well, which is why we advocate them in our personal finance system, Breaking Free. When you commit to accountability with someone you respect, you risk the embarrassing loss of your reputation if you don't follow through. This is putting your reputation on the line, and it works.

Office weight loss programs are effective because they often put reputation and money on the line. When ten people at work pool money together to give to the weight loss winner, the game is on! We are extremely motivated by the prospects of social and monetary loss. One reason people pay high prices for schooling or training is to motivate themselves to study. I paid a lot for this, I'd better work hard and get something out of it, they think to themselves. Yale professor Dean Karlan started a website around the idea of a "commitment contract," where someone declares their goal, puts up money for a friend or charity, and agrees to lose that money if they don't keep their commitment. The site is extremely successful, because it taps into the powerful force of loss aversion.

Our chance of change goes up when we start effectively using the fear of losing.

about erik van alstine

Erik is a change expert and author of the personal finance discipleship system, Breaking Free: Financial Strategies that Transform Debt into Wealth. Breaking Free is like driver's ed in your financial life, a powerful video curriculum that offers experiential learning, assessment, and transformation! Take our free MoneyFinder Quiz to see just how much payoff Breaking Free can create for you!