We pass up excellent opportunities to make larger gains, purely because we are desperate to avoid small losses. But doing so might be to our disadvantage
As I write these words, I am already contemplating my New Year’s resolutions, and my attempts to use the toolkit of behavioural economics grow ever more intricate. This year the enemy is “loss aversion”, a phenomenon identified by the psychologists Daniel Kahneman (a Nobel laureate) and the late Amos Tversky.
Loss aversion sounds like an odd label, because it might seem perfectly reasonable to be averse to losses. Technically speaking, loss aversion is something more than that: it is a disproportionate anxiety about losses. When we pass up excellent opportunities to make larger gains, purely because we are desperate to avoid small losses, that is loss aversion at work.
And it is rarely wise, since the difference between “losses” and “gains” is often rather arbitrary – a benchmark that is easily manipulated.
(Naturally it is in the interests of casinos to make you think you’re gambling with the house’s money, so that everything feels like a possible gain, because that will make you more willing to take risks. In contrast, expect insurance salesmen to emphasise the status quo that must be protected against loss.)
Loss aversion might seem to have little to do with New Year resolutions, but I think it does. My resolution this year is to risk more small losses. The world is full of overpriced insurance or insurance supplements, designed to remove the risks of having to replace a cracked mobile phone or a dented bumper. But as a paid-up member of the economics profession, I’ve avoided such nonsense for years, so this doesn’t make for a good new resolution.
But there are other small losses, which we are tempted to avoid to our disadvantage. These are the little experiments in life: going to the party where we might meet someone interesting; the new class we were thinking of taking up; the hobby we wanted to try out. Peter Sims’ book Little Bets is full of examples in the work habits of successful creative people, from architects to stand-up comics.
So I’ll be trying something new each month in 2013, and I’ll be fighting loss aversion all the way. I have a few plans. I’d like to write a short story, organise an intellectual salon, hire a personal trainer, learn to program and bake chocolate cake.
Now you may have heard such wheezes before, but this is a little different. The whole point is that I don’t really expect much of this to work out. The personal trainer will probably be a waste of money; the salon is likely to be awkward and disappointing; I have no need to program and nobody is ever going to publish my short story.
As for baking, I did try to learn to bake bread last year, visiting my brother-in-law’s bakery beside Oxenholme railway station. I had fun – but I have never found the time to bake anything at home.
This is the point: none of these losses will amount to a hill of beans. I expect to waste a few hours and a few quid. I don’t expect to regret any of it, because none of this is really supposed to pan out. Some of these projects will remain firmly on the drawing board for the entire year. It simply does not matter because these losses are all small. And you never know: one of these days, one of these projects may turn out to be hugely fulfilling. That will justify all the failed experiments along the way.
Loss aversion grips many organisations. Far too often, new ideas are turned down because they will probably fail, without seriously asking whether the small chance of meaningful success might outweigh an inexpensive failure – even if that failure is highly likely.
Most resolutions are things we decide to do because we’re convinced they will be to our benefit. My aim is to do things that I suspect will fail.
Also published at ft.com.