One who hates to lose avoids profit

Let’s pretend you stand in front of a dilemma where you were to pick one investment option:

Investing $20 for $50 with a 100% chance

OR

Investing $20 for $100 with an 85% chance

Which one would you pick? Shoot.

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Well,

If you went for the second option, congrats, you’re one of a kind.

Picked the first option? You’ve been fallen into the “loss aversion” trap.

Simply put, ‘loss aversion’ is a term used in psychology and economics that refers to people’s tendency to prefer avoiding losses so they can acquire equivalent gains.

Even simpler, losing $20 is more powerful than earning $80.

The basic psychological fact is that people are very sensitive to change.

Let’s demonstrate this by the following experiment:

Take your right hand and put it in a — bucket of cold water and your left hand in a -bucket of warm water (It should not be too hot).

Then move both hands into a bucket with lukewarm water.

What do you feel?

Your right hand will be warm and your left hand will feel cold. Although both hands are at the same temperature.

According to Professor Daniel Kahneman, the same goes for our decision making in business.

The change (gains & losses) is what determines our decisions, not the overall outcome (the total person’s fortune).

Knowing the existence of loss aversion and how to use it for your own benefits can help a lot during the negotiation process.

For example, what would be a better investment offering?

A 50% chance of turning 300K to 315K

OR

A 50% chance of turning 300K to 290K?

It is worth pointing out that some rules might change when the endowment effect takes place but that’s an entirely different post.

Thank you for reading.

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Image Credit: http://www.saltfinancialgroup.com.au/