Thinking Slowly About Loss Aversion

Nobel prize-winning behavioral economist Daniel Kahneman passed away at the age of 90 a few days ago. Kahneman was a marvel. He proved through meticulous research that people’s mental biases — what he called kinks — warp their judgment and often lead them to act against their own self-interests. 

In his book, Thinking Fast and Slow, Kahneman made the case for rejecting intuition, the fast decision-making he called System 1 thinking, and to prefer a slow and deeper analysis where experience and data could be explored together (System 2 thinking).  Fast thinking is emotional, while slow thinking is analytical. 

In his work, Kahneman set out to prove how wrong people can be and showed how experts tend to be overconfident and make fast predictions that lead to faulty judgments and decisions. According to Kahneman, too many important decisions tend to be driven by intuition, to the detriment of more favorable outcomes. 

Of the many critical discoveries Kahneman made during his illustrious career, his work on loss aversion stands out for its influence on everyday decision-making. Kahneman found that people experience more psychological pain from losses than they do pleasure from equivalent gains. In other words, the loss of $1000 hurts psychologically twice as much as the pleasure of gaining $1000. 

People prefer to avoid loss more than they like achieving gains, and they focus their attention in just that way. This is why golfers make more putts for par than for birdie, why tennis players rarely miss the second serve, and why consumers are more likely to purchase unnecessary insurance and warranties. 

Because of the loss aversion bias, people overestimate the probability of negative events happening. Any time a choice is framed or perceived as risky, people work harder at avoiding loss than on making gains. 

This helps to explain why individuals may stay in unhealthy relationships when it is clearly not in their best interest to do so, why team members prefer to stay in a role or position rather than seek a new opportunity elsewhere, and why leaders tend to focus more on issues that dampen risk than to engage in tasks that could lead to breakthroughs. 

Guarding against loss aversion can be challenging. Some psychologists have even argued it may be hardwired into the human brain. Nonetheless, taking the time to accurately assess the risks involved within the broader context or big picture will often reduce its impact. Emphasizing opportunities, gains, and growth, as opposed to risks and potential loss, is a mindset good decision-makers develop on purpose. Kahneman would be proud.