Welcome back to Wayfinder, your fortnightly compass for navigating life’s toughest decisions. Today we're talking about a fundamentally human bias - loss aversion.
First, let me tell you a story.
The view from 30,000 feet
High above the world, where the air is thin and the sky touches the earth, lies the ultimate test of endurance, will, and decision-making: Mount Everest.
The year was 1996, and the mountain was bustling with climbers, all vying to etch their names in the annals of history alongside the small number of those who have conquered Everest. Among them was a team led by a seasoned guide, Rob Hall.
The rule for summiting Everest is clear – turn back by 2 PM, no matter where you are, to avoid the deadly afternoon storms.
On that fateful day, as the clock inched towards the cutoff time, Hall's team was near the summit but not quite there. Here, the sunk cost fallacy reared its head. Months of training, thousands of dollars spent, and immeasurable effort loomed in the minds of the climbers. Turning back now would mean all that investment was for nought. Or so it seemed.
In the grips of loss aversion, the reluctance to accept a loss on their sunk costs, the team pushed on, breaching the 2 PM rule. The summit was reached, but as they say, the summit is only the halfway point.
Disaster struck on the descent. A storm, fierce and unforgiving, enveloped the mountain. The team, exhausted, disoriented, and now battling the merciless weather, struggled to make their way down. In the whiteout, decisions became matters of life and death.
Rob Hall, unable to descend, radioed a heartbreaking farewell to his pregnant wife. In the end, five members of the expedition, including Hall, perished. Their decision to push beyond the turnaround time – driven by the desire not to lose their invested effort and resources – led to a tragic outcome.
This story is a chilling reminder of how the fear of loss can cloud judgment, even among the most experienced.
Losses are everywhere
Loss aversion is a term from behavioural economics, referring to our tendency to prefer avoiding losses rather than acquiring equivalent gains.
It runs deep in our brains.
Neurological Basis of Loss Aversion (Tom, Fox, Trepel, & Poldrack, 2007):
In a groundbreaking study diving into our brain's wiring, researchers used neuroimaging to reveal how we process potential losses and gains. They found that the threat of losing something provokes a more substantial emotional response in our brains than the prospect of an equivalent gain. This neural activity, particularly in areas linked to emotions like the amygdala, provides biological evidence for loss aversion, showing its deep-rooted presence in our decision-making processes.
The pain of losing is psychologically about twice as powerful as the pleasure of gaining. This can lead to a range of poor decision-making scenarios:
- Financial Investment Decisions: Many investors hold onto losing stocks for too long, hoping they'll bounce back to the original buying price. This reluctance to realise a loss (and admit a bad decision) often leads to greater losses in the long run, as they miss out on investing in other, potentially more profitable, opportunities.
- Consumer Behavior: We often stick with services or subscriptions we don't use or need, simply because we've already paid for them. Think about your gym memberships, software subscriptions, or streaming services. The thought of 'wasting' the money you've already spent keeps you locked into ongoing expenses.
- Career Choices: It's easy to stay in unfulfilling or poorly matched jobs to avoid the perceived loss of leaving (like losing seniority, familiar routines, or vested benefits), even when there might be better opportunities elsewhere. This can lead to prolonged dissatisfaction and missed career growth. We talked about this at length in a previous Wayfinder issue.
- Relationships: In personal relationships, loss aversion might keep you in an unhappy or unhealthy relationship due to the time, energy, and emotion already invested, despite clear signs that leaving would be beneficial in the long term.
- Health and Lifestyle Choices: We often persist with unhealthy habits (like smoking or overeating) to avoid the discomfort (loss) of changing these habits, despite knowing the long-term benefits of doing so. The loss of giving away the last doughnut always feels worse than the gain of lower calorie intake.
- Selling Property: Homeowners may refuse to sell a property at market value if it's lower than the purchase price, even if holding onto the property is financially disadvantageous due to maintenance costs, taxes, or a declining market.
The Endowment Effect (Knetsch, 1989):
In a revealing study by Jack Knetsch, participants were initially given either a mug or a pen. Later, they were offered the chance to swap their item for the other. Strikingly, most clung to what they had, despite the items being of equal value.
This experiment underscores our natural inclination toward loss aversion: once we possess something, we irrationally overvalue it, fearing the loss more than appreciating the potential gain of something new.
Here are some questions to think about:
- Have you ever found yourself continuing down a path simply because of the time, money, or effort you've already invested, even when signs suggested it was time to turn back?
- How can you create personal or professional 'turnaround times' to avoid the trap of sunk cost fallacy in your decisions?
- What strategies can you employ to recognize when loss aversion might be clouding your judgment, especially in high-stakes situations?
Recognising when you're in the grips of loss aversion is crucial for rational analysis. It involves stepping back to assess situations objectively and being willing to accept short-term losses for long-term benefits.