Loss aversion is when investors try harder to avoid losses than to make gains, leading to status quo bias and reluctance to take financial risks. It can be avoided by focusing on similar benefits rather than concrete differences, and marketers use it to drive product awareness.
Loss aversion is the term applied to the tendency of investors to try to avoid a loss even harder than they try to make a gain. Studies have shown that investors are more likely to sell a good stock to make a profit than they are to sell a bad one to minimize losses. Psychologically, people tend to experience losses more acutely than victories, and a loss often leads to feelings of regret. Regret can lead people to confuse a bad outcome with a bad decision and, in extreme cases, have pervasive effects on their confidence in decision making.
The economy can be affected by people’s natural tendency toward loss aversion, especially in times of economic hardship. This is one of the reasons why people are reluctant to upgrade expensive durable goods and take financial risks. Sellers see the goods as a loss, and the price is the same. Buyers see merchandise as a gain and budget accordingly. Problems occur when the seller and buyer don’t see the value of the item.
The real-world result of loss aversion on both sides of the negotiating table can lead to status quo bias, which is an inherent preference for things to remain as they are. Nothing is gained, but nothing is lost either. When assessing risk, especially financial risk, a certain type of individual or company tends to prefer the security of the playing field to the stress of a gamble.
Loss aversion can be avoided if the purchased item has the same benefits as the traded item, even if it has different attributes. For example, buying a car is basically just exchanging a certain amount of money for a car. If the customer feels that the car would serve him as well as that amount of money, the transaction will be completed without reluctance, even though the car and money are two very different things. Studies have shown that focusing on concrete differences between two items (driving a car and spending money) can lead to more loss aversion than focusing on similar benefits (both allow for a level of freedom).
Marketing departments take advantage of loss aversion to drive their product into public awareness. Free trial programs operate on the idea that once a customer tries a product, they are evaluating how much they would pay to avoid losing that product, rather than getting it. Late payment programs work the same way. Standing in the store, looking at a television, a consumer might refuse to pay the $3,000 price tag. Since the television has been in his house for a few months and he’s been enjoying it with his family every night, he’s much more likely to decide it’s worth $3,000 to avoid losing it.
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