Part V · Chapter 10 · Behaviour · lesson 2
Losses hurt about twice as much
11 min
Builds on Volatility is not risk, except when it is
Part V · Chapter 10 · Behaviour · lesson 2
11 min
Builds on Volatility is not risk, except when it is
Another pair of questions. Same rule as last time: answer as you would, not as a textbook would.
What would you do
Second question. Different envelope, otherwise the same room and the same person making the offer.
What would you do
Gains and losses are not measured on one continuous scale running through zero. They are measured from wherever you currently stand, and the two directions do not have the same slope. Moving down from your reference point registers as a bigger event than moving the same distance up.
That single asymmetry produces the reversal you have just been through. Framed as a gain, the certain outcome looks good and the gamble looks like risking something you already feel you have. Framed as a loss, the certain outcome is an accepted defeat, and the gamble is a chance of getting away with it.
The important word in that concept is reference point, because it is not fixed and it is not chosen deliberately. It is usually whatever you last got used to. This is why a pay cut from a level you have held for two years lands harder than never having had the money — the arithmetic is the same and the starting line is not.
The asymmetry does most of its damage through one specific behaviour: people sell things that have gone up and hold things that have gone down.
The reasoning underneath is not stupid. Selling something at a loss is the moment the loss stops being provisional and becomes a fact about you. Holding keeps it hypothetical. So the position that is doing badly gets kept, on the grounds that it might come back, and the position that is doing well gets sold, on the grounds that a gain you have banked cannot be taken away.
Check
It would be a mistake to leave this lesson thinking the asymmetry is purely a malfunction. Something that survives in every population tested is usually doing a job.
The job is survival. In a world where you are close to the edge, a loss of a given size genuinely is more consequential than a gain of the same size, because losses can take you below a threshold from which there is no recovering and gains cannot take you above one. Weighting the downside heavily is the correct policy when ruin is on the table — a whole track of this course is about exactly that.
Loss aversion is a survival rule that does not check whether survival is actually at stake.
Applied to a decision where the worst case is a smaller number in an account, it makes you hold bad positions and sell good ones. Applied to a decision where the worst case is losing your home, it is the reason you still have the home. The rule is the same. Only the stakes tell you whether it is helping.
Once the asymmetry is visible, a set of otherwise unrelated tactics turns out to be one tactic.
A trial that has to be cancelled. By day thirty you are not deciding whether to buy. You are deciding whether to give something up.
A price shown as a saving. The same amount is a gain foregone or a loss avoided depending on which number is printed larger.
Loyalty points that expire. The points were never money, but once they are in the account they are yours, and losing them is a loss.
A free upgrade with an end date. Everything above, at once.
None of these are frauds. They are competent uses of a real feature of how people evaluate outcomes, and the same feature is used by your bank at track 4 and by an outright scheme at track 12. The mechanism does not know which one it is being used by.