Loss Aversion

Balancing stones

Why the negative strikes fear more than the positive and how to overcome it.  As a self-employed real estate and engineering consultant (yes = sales!), I was tallying up my overall debt to asset ratio tonight to determine my net worth (and where it is going- but that is another topic).  My assets by far outpaced my debt (ya me!).  I was actually quite surprised because I have been operating in a state of panic since re-careering into this new realm of full commission!  It got me thinking about the power of the negative and, more importantly, how to turn it around.

It is a commonly known human phenomenon that negative outcomes effect decision making more than positive. Well, perhaps not commonly known, but any University of Florida MBA (my Go Gators! plug) is intimately familiar with Daniel Kahneman’s Noble Prize (Economics) winning Prospect Theory.  Daniel Kahneman, with Amos Tversky, theorized that people’s decision making behavior, particularly applied to economic decisions, was governed more on the potential risk of loss rather than the final outcome. This is basic loss aversion.

Moreover, they described that the loss may actually be a lesser gain than an alternative rather than an outright loss.  This, of course, depends on the reference used in evaluating the options.  Kahneman theorized that people judge the risk based on a frame of reference.  Alternatives less than the frame of reference were a loss even if they were simply a lower gain.

Without going into the statistical probability comparisons and calculations (because we all love statistics and math!), the crucial take away of the Prospect Theory is learning how to best frame, bundle and present options. Taking my net worth example above, for instance, instead of looking at my debt level separate from my assets, I should focus on the net assets (and be glad assets are higher!)

Take my advice – frame it in the positive to better guide the decision.

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