Updated on 03.08.08

Loss Aversion and Motivation: Using Your Natural Instincts To Get Ahead

Trent Hamm

Yesterday on my way to work, I was tuned into NPR’s Morning Edition and I overheard a story about two researchers using our natural instinct to avoid losses as a motivation to lose weight.

The concept is called loss aversion and is summarized by Wikipedia as such:

[L]oss aversion refers to the tendency for people strongly to prefer avoiding losses than acquiring gains. Some studies suggest that losses are twice as powerful, psychologically, as gains.

Quite often loss aversion is a very dangerous thing when it comes to personal finance and investing. Loss aversion is the explanation for why people get nervous and want to sell stocks when their value is dropping, even if they have good reasons for owning those stocks and it’s a great long-term investment. You have to fight against your natural tendencies to succeed as an investor.

But can this natural tendency be helpful? Here are some ways where loss aversion can actually help with your finances.

Recognize it I realize now that the biggest thing keeping me on my insane schedule of the last two years was loss aversion. I was so afraid of losing something that I threw everything I had at juggling a lot of balls. It was only after some careful reflection that I began to see that I was doing all of this out of an aversion to loss – and that aversion was keeping me from really succeeding. I was so scared of failing at all of these things that often I wasn’t trying with my whole heart to succeed, just to not fail. Once I realized that, it became a lot easier to look at my life and see what was most valuable to me: my children and my family and writing, and I made the powerful decision to leave a “safe” job to really become a better parent and a better writer.

Set goals The more detailed and specific your goal is, and the more attainable it is especially in the short term, the more of a “loss” you feel when you don’t achieve it. Here’s an example: wake up in the morning and pledge to yourself that you won’t spend any unnecessary money today. Put a little card noting that pledge on your pillow. That night, when you see the pledge, you’ll either (a) feel success at your first step or (b) feel a big swoon for having failed this little goal. Eventually, you’ll start becoming averse to that loss of positive feeling – and when you know that the actual route to avoiding that loss is simple, you’ll start doing it.

Use a big carrot Tell your wife that if you guys together can bank $10,000 this year, you’ll spend $4,000 of it and take the family to Disneyworld (or some other prize). You’ll both work towards that goal quite intensely, finding ways to save money and invest it well. The aversion to “losing” that vacation becomes a motivator, and having someone else work with you towards the goal will help, too.

Invest more conservatively If you find the swoons of the stock market make you sick and trigger those “loss aversion” feelings, causing you to make bad investment decisions, consider investing more conservatively. Put your money into bonds that will steadily earn over time. You might want to even keep things in cash in a high-yield savings account. This isn’t a “losing” route, as many people will tell you – it’s a losing route to buy stocks and then sell them when the market goes down and your loss aversion is going crazy. A steady 5% or 6% return, year in and year out, with no worries, is not a poor choice, especially if you’re prone to loss aversion.

In short, knowing that people have a natural loss aversion and recognizing it when it happens is the real key to maximizing that feature of human psychology for yourself.

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  1. Interesting post. I think I have had this problem in the past when I have delayed paying down debt because I don’t want to see my checking account balance drop. Frequently I would end up not paying the full amount I wanted to b/c I spent it on other things. I now try to put that money towards debt as quickly as possible.

  2. Saving Freak says:

    Very good post. So many times we give up gains for fear of losing. I think budgeting is one way to get over such fears. If the money is earmarked for a specific purpose or investment you are much more likely to follow through.

  3. Sophie says:

    “Tell your wife that if you guys together can bank $10,000 this year, you’ll spend $4,000 of it and take the family to Disneyworld (or some other prize).”

    I’m kind of bothered by the implication that the little woman will just follow along and do what she is told once she has an appropriate ‘carrot’. Trent, I like some of the things you write, but there is the odd comment like this that makes me think that you’re not writing for me, you’re writing for my husband, the man of the house who makes the important decisions.

  4. Tom W says:

    So true. I think it’s a good idea to think about it in terms of losses instead of gains. I once played a game of poker this way, and it seemed to work in my advantage.

  5. Sabrina says:

    Great strategies and insight. I enjoy your posts on the psychology behind why we do the things we do; you take the theorizing and show the immediate practical applications. Brain hacking in the pursuit of personal finance?

  6. Johanna says:

    “Tell your wife”????? You do realize that you have readers who are not married men, don’t you? Or do they not count?

  7. Trent Hamm Trent says:

    I kind of assume that my audience is intelligent enough to realize that discussions between spouses is a discussion between equals, and that I refer to talking to my wife because that’s the experience I’m familiar with – I don’t *have* a husband.

  8. Sophie says:

    Okay, I get what you meant, but that’s not necessarily what your post said. If my husband said to me “Honey, if you can help me save $10,000 this year I will spend $4000 taking us to Disneyworld.” we would have a serious discussion on our hands- I would think he was being patronising and treating me like a child who needs the promise of Disneyland to get me to comply.

    I do quite often get the feeling from your posts though that you are the head of the household as far as financial decision making is concerned. you often refer to decisions “I” made, rather than decisions “we” made. If that works for you and your wife, that’s your business and nobody should have an opinion on that but you guys. But I am interested to hear whether that is how it works, and how your wife feels about the decision, for instance, to stop work. Presumably she needs to keep working for insurance reasons? I would be fascinated by her point of view on that.

  9. FIRE Finance says:

    We’re die hard optimists and are motivated by the joys of life. Fear and thus fear of loss has seldom helped us pursue any project. On the other hand a vision of creating something new in a disciplined manner and watch it unfold through our hard work and integrity gives us great joy. It also helps us to accept risks and ride through them successfully. Fear of losing can get us only so far. In joy lies the seed of everlasting peace and happiness.

  10. Kate says:

    Make sure if you dangle the carrot that you are willing to do what you are dangling if the goal is achieved. As in willing to do it without rethinking it out loud.

  11. InvestEveryMonth.com says:

    Looking at situations and goals from the loss potential instead of the gain potential is like realizing there is another image in one of those “what do you see” pictures.

  12. FrugalRandy says:

    Folks need to remember this is a BLOG. If you don’t like the fact that Trent is a man who presents his thoughts through his own eyes to form his own unique life COMMENTARY, then any of the readers here can probably direct you to hundreds of blogs written by and for females. It’s not his job to walk on eggshells for you.

  13. Julie says:

    Sophie, I get where you are coming from…I sort of gather that Mrs Trent just isn’t interested as there are never (not that I have read anyway) any posts about disagreements or differences of opinion they’ve had about a decision. I would think that would be relavent and not too personal, but maybe I’m wrong. I handle all the details of our budgeting, bill-paying, investing, etc, but my hubby and I discuss everything. We can both view everything online and on the computer and I make sure he knows how to read all my tracking spreadsheets, etc. He’s just not as into it as I am, but I still want him to know how I track everything and he’s knows a lot more about stocks than I do and follows that end of it. We all have our strengths. Maybe Mrs Trent just prefers to just be consulted from time to time instead of worrying that much about it. Who knows. It appears that way anyway from, like you mentioned, all the “I’s” rather than “we’s”. I too would like to hear her opinion on the quitting work scenario. I’m assuming she didn’t want to do this herself to be home with her children? That was very important to me, but it’s not to everyone and I respect that.

  14. reulte says:

    Trent – For the most part I prefer to see you writing “I” because you are writing about your experiences, but remember that many discussions between spouses are NOT discussions of equals.

    FrugalRandy – it IS his job to write for his audience (particularly since he is now doing this as his main employment) and women are part of his audience – not to cry mea culpa at the least little criticism but simply to be aware of how others may take phrases.

  15. erbe says:

    I like the way you manage to connect so many things to personal finance. Keep it up.

    BTW, when I read the paragraph about the carrot, I simply took it that the spouse who is making the suggestion is taking the lead in coming up with the plan on how to structure of the reward. A wife could easily be the one dangling the carrot and coming up with the plan. Or both could come up with plans. In some marriages, one spouse may find it easier to motivate with a carrot of some sort. When it comes to spending money, often spouses do not agree on when to spend and when not to. He spoke from the husband’s point of view, because he is a husband.

  16. I heard the same article, and my heart sank because it explains a lot about why people somehow don’t get excited about switching from Microsoft to Openoffice (my field) because gaining money they currently spend on MS Office is less appealing than losing their comfort zone. (Not apples to apples but it’s relevant I think.) I think the vacation analogy is good for my field — tell teachers looking at a possible switch that if you will switch to OpenOffice, we’ll spend a fourth or a half of the money on getting teaching assistants, perhaps.

    Did you hear the next story in NPR, immediately after loss aversion? People get a better placebo effect from the more expensive placebo, i.e. the sugar pill that subjects were told cost more. That’s an issue for money management and for switching to a free office suite.

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