“Everything is relative in this world, where change alone endures” (Leon Trotsky)
IF you were offered the chance to win or lose $100 on the basis of a coin flip, would you take the bet?
If you are like most people, you would probably decline the wager.
Even though the gamble offers an even chance of winning, the stakes are unattractive since the suffering from a loss would be felt much more deeply than the joy from winning.
Economists refer to this as loss aversion, and the emotional impact from a loss is thought to be around twice that of a comparable gain.
While it is convenient to talk about losses as being “twice as powerful”, research suggests that loss aversion will tend to vary from person to person, in different situations, and for the same person at different points in time.
Below we highlight 5 factors that have been shown to influence how much loss aversion a person will feel.
1. Everything is relative
Leon Trotsky is quoted as saying that “everything is relative in this world, where change alone endures”, and Trotsky may well have been talking about loss aversion.
Due to the way that people mentally account for things, gains and losses tend to be evaluated in relative terms. For example, if you lose $100 from a stock portfolio worth $10,000 then you are likely to suffer much less than if the entire portfolio was worth only $100 and you lost the lot.
Nat Novemsky and Danny Kahneman explain that our intentions for a good define whether it is “an object of exchange or … an object of consumption, and therefore … determine whether giving [it] up … is evaluated as a loss or a foregone gain.”
What exactly does this mean?
Well, imagine you have an iPhone. If you are carrying it around with you and someone steals it, then you have suffered a loss. Alternatively, if your intention is to sell the iPhone (because you want to get a Samsung Galaxy) and a good friend offers you $600 for it, but you end up giving it to her for free, then that’s a foregone gain. In each case the result is the same (no iPhone and no money), but the first situation, the one where you suffered the loss, will be more distressing.
3. Duration of Ownership
A person will tend to view a product as more valuable if it has been owned for a longer period of time. For example, if you have a well-worn pair of slippers that you have grown to love, then you will probably be reluctant to throw them away (probably even if they are riddled with holes).
A person will find it easier to give up a product if it is exchanged for something that affords similar benefits. For example, you will be much more likely to sell your old car if it is exchanged as a trade-in for a new car which has comparable features.
It will probably come as no surprise that older people are more loss averse.
It is easy to imagine a situation where a budding 20-something might be prepared to risk her entire life savings on an entrepreneurial venture, whereas a middle-aged woman might be less enamored by the idea.