3 min read
Loss Aversion


It’s your lucky day! You meet a kind stranger who offers you your choice of a great deal, something for nothing. No tricks, really: you’re getting a free lunch. 

 

She gives you $45. Then, she asks if you want to keep that money, or give it to her in exchange for a coin flip, where if it’s heads, she’ll give you $100, and if tails, you get nothing.

 

Which do you choose? Do you want $45 in cold, hard cash in your pocket, or are you willing to take a chance with the coin flip? Decide before reading further. 


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When I present this scenario in my speeches to business audiences, about 80 percent say they’ll take the $45 from the kind stranger. I made that choice when I first learned about this scenario, and so do most people in studies of similar choices. 

 

After all, the $45 is a sure thing. Wouldn’t I feel foolish if I took a risk and lost it all for just a chance at getting the $100? My gut reaction was to avoid losing out. After all, who wants to be a loser, right?

 

Well, let’s run the numbers. The chance of getting heads is 50 percent, so in half of all cases you’ll win $100, and in the rest you won’t win anything. That’s equivalent to $50 on average, versus $45.

 

Imagine you flipped a coin 10 times, 100 times, 1,000 times, 10,000 times, and then 100,000 times. At 100,000, on average you would get $5 million if you chose the coin flip for $100 each time, versus $4.5 million if you chose $45 each time. The difference: a cool $500,000.

 

Thus, unfortunately choosing $45 as your gift actually resulted in you losing out. The right choice – the one most likely to not cause you to be a loser – is to choose the coin flip as the gift. Otherwise, over multiple coin flips, you’re pretty much guaranteed to lose.

 

But wait, you might be thinking: I presented this as a one-time deal, not a repeating opportunity. Maybe if I told you it was a repeating scenario, you’d have thought about it differently.

 

I felt the same way when I was presented with the coin flip dilemma: I would have done things differently if I was told it was a repeating situation.

 

Here’s the problem. Research shows that our gut treats each individual scenario we see as a one-off. In reality, we face a multitude of such choices daily. Our intuition is to treat each one as a separate situation. Yet, these choices form part of a broader repeating pattern where our intuition tends to steer us toward losing money. 

 

That gut reaction is called loss aversion, one of the many dangerous judgment errors that result from how our brains are wired, what scholars in cognitive neuroscience and behavioral economics call cognitive biases.

 

Fortunately, recent research in these fields shows how you can use pragmatic strategies to address these dangerous judgment errors, whether in your professional life, your relationships, or other life areas

 

You need to evaluate where cognitive biases are hurting you and others in your team and organization. Then, you can use structured decision-making methods to make “good enough” daily decisions quickly; more thorough ones for moderately important choices; and an in-depth one for truly major decisions.

 

Such techniques will also help you implement your decisions well, and formulate truly effective long-term strategic plans. In addition, you can develop mental habits and skills to notice cognitive biases and prevent yourself from slipping into them.

 

Your professional life – anyone’s professional life – is made of 100,000 coin flips. The stranger’s gift represents the series of opportunities we face in our lives, and we can either win $5 million or $4.5 million depending on the choices we make for each one.

 

The same applies on an organizational level. Let’s say your company has an annual revenue of $50 million, and a healthy profit of $7.5 million. Regardless of the choice you’re making, if other employees in your organization are going with their gut to avoid losses, and the company loses 10 percent of its revenue or $5 million per year, then two-thirds of your profit will be wiped out, leaving only $2.5 million.

 

Every day, you face a series of situations where you need to decide whether to take the course that feels most comfortable by avoiding losses, or the course that feels less comfortable and leads to more gains over time. We’re not talking about huge bet-the-company risks – which require a different approach – but the kind of small decisions that add up to large sums over time. If you just go with your gut instead of doing the calculations and going with the data, you are likely to lose much more money by not taking the course that feels most risky. 

 

To prevent your intuition from leading you astray, adopt a policy of letting the data lead you, instead of relying on your intuitions. For each decision you face, envision it as a repeating pattern, instead of a one-time decision: run the numbers, account for the role of uncertainty, and take the course most likely to lead to the biggest profit. 

 

Treating each choice as part of a broader pattern might feel counterintuitive, uncomfortable, and unsafe. Yet the course that feels most safe of avoiding losses is actually much more dangerous for your bottom line. 

 

Key Takeaway

 

Our feelings drive us to avoid short-term losses, which often results in us failing to take worthwhile risks and actually losing more in the long term. This problem comes from a dangerous judgment errors called loss aversion. Click To Tweet

Questions to Consider  (please share your thoughts below)

 

  • Where did you see loss aversion lead to problems in your team or organization?
  • How might your organization and team benefit from avoiding loss aversion?
  • What next steps will you take to address loss aversion in your team and organization?

Image credit: Wikimedia commons

 


Bio: Dr. Gleb Tsipursky is on a mission to protect leaders from dangerous judgment errors known as cognitive biases. His expertise and passion is using pragmatic business experience and cutting-edge behavioral economics and cognitive neuroscience to develop the most effective and profitable decision-making strategies. A best-selling author, he wrote Never Go With Your Gut: How Pioneering Leaders Make the Best Decisions and Avoid Business Disasters (2019), The Truth Seeker’s Handbook: A Science-Based Guide (2017), and The Blindspots Between Us: How to Overcome Unconscious Cognitive Bias and Build Better Relationships (2020). Dr. Tsipursky’s cutting-edge thought leadership was featured in over 400 articles and 350 interviews in Fast Company, CBS News, Time, Business Insider, Government Executive, The Chronicle of Philanthropy, Inc. Magazine, and elsewhere.

His expertise comes from over 20 years of consulting, coaching, and speaking and training experience as the CEO of Disaster Avoidance Experts. Its hundreds of clients, mid-size and large companies and nonprofits, span North America, Europe, and Australia, and include Aflac, IBM, Honda, Wells Fargo, and the World Wildlife Fund. His expertise also stems from his research background as a behavioral economist and cognitive neuroscientist with over 15 years in academia, including 7 years as a professor at the Ohio State University. He published dozens of peer-reviewed articles in academic journals such as Behavior and Social Issues and Journal of Social and Political Psychology.

He lives in Columbus, OH, and to avoid disaster in his personal life makes sure to spend ample time with his wife. Contact him at Gleb[at]DisasterAvoidanceExperts[dot]com, follow him on Twitter @gleb_tsipursky, Instagram @dr_gleb_tsipursky, Facebook, YouTube, RSS, and LinkedIn. Most importantly, help yourself avoid disasters and maximize success, and get a free copy of the Assessment on Dangerous Judgment Errors in the Workplace, by signing up for his free Wise Decision Maker Course.