...the Fear of Losing Money

Dianne M. Berlin

READ!! Why they don't promote losing!! New Year's Resolutions and the Fear of Losing Money : The New Yorker
http://m.newyorker.com/online/blogs/currency/2014/01/new-years-resolutions-and-the-fear-of-losing-money.html

January 2, 2014

New Year’s Resolutions and the Fear of Losing Money

Posted by Adam Alter

 

 

To commit to a New Year’s resolution is to gamble. Gym memberships and weight-loss programs are expensive, but they’re good investments if they bring health and happiness. Unfortunately, as I learned eight years ago, people don’t take the prospect of losing money lightly. In the summer of 2005, I interviewed dozens of habitual gamblers in Atlantic City. I waited as they stumbled from the casino onto the boardwalk, squinting into the sunshine, and asked each one a string of questions about their gambling beliefs. Many believed that a roulette wheel could become “stuck” on red or black (known as the hot-hand fallacy). Others felt that the same roulette wheel was “due” to spin red after a string of black spins (the gambler’s fallacy). The most consistent response came when I asked some of the gamblers whether they would consider playing a simple, hypothetical game: I would toss a coin. If it came up heads, I would give them ten dollars; if it came up tails, they would give me ten dollars. This is a perfectly fair gamble—fairer than many casino games, which are designed to favor the house—but the appeal of winning ten dollars wasn’t enough to overcome the potential pain of losing ten dollars. Almost all of them said that they would prefer not to play.

The pain of losing ten dollars looms larger than the gain of winning ten dollars because most humans are loss-averse. In the past eight years, I’ve presented the same hypothetical game to rooms filled with bankers, insurance agents, salesmen, marketers, and design experts—and fewer than five per cent have been willing to gamble. (If you sweeten the payoff, so that they stand to win twenty-five dollars versus losing ten dollars, about half of the people in the room are willing to play; sweeten it further, to a fifty-dollar gain versus a ten-dollar loss, and almost everyone wants in.)

Almost three decades have passed since the psychologists Daniel Kahneman and Amos Tversky first demonstrated loss aversion. Since then, other researchers have shown that loss aversion drives real, long-term behavior beyond hypothetical lab experiments. In one field experiment, four economists offered to reward Chicago schoolteachers according to how much their students’ test scores improved during the 2010-2011 academic year. The teachers stood to earn up to eight thousand dollars (roughly eight per cent of their annual salaries) if their students improved significantly more than other students with similar starting test scores. The economists promised one group of teachers that they would get the reward at the end of the year. With another group, they handed out four thousand dollars at the beginning of the year, and told the teachers that they would have to return some of the money if their students’ improvement fell short of the average gain. Most reward schemes, from annual holiday bonuses to sales commission, work according to the first approach.

They promise compensation for good performance. But the second approach was novel, capitalizing on the sting of loss aversion. The teachers in the second group coaxed roughly five per cent more improvement from their students than did teachers in the first group, presumably because the prospect of having to return money at the end of the year motivated them to devote more care and effort to teaching.

The gamblers in Atlantic City and the teachers in Chicago believed that losses would hurt them more than gains would help. But were they right? Perhaps people are actually more resilient to losses than they tend to believe. Until recently, it was difficult to measure how painfully losses stung and for how long, but a recent paper suggests that the gamblers and teachers were wise to be cautious. Five European economists and psychologists measured how fifty thousand German and British workers responded when their incomes rose and fell between 1998 and 2009. At the end of each year, the German respondents indicated how happy they were on a scale that ranged from “totally unhappy” to “totally happy.” The British sample completed the General Health Survey, which measured the presence of twelve signs of psychological distress.

Both groups were sensitive to changes in their income, but a loss of a thousand dollars was more than twice as damaging as a gain of a thousand dollars was helpful. I mentioned earlier that the people I surveyed were unwilling to play a fair gamble unless the prize for winning was two-and-a-half times greater than the punishment for losing—and that pattern resonates with the outcomes of the European study. The researchers were careful to consider a long list of factors that may have magnified the impact of losses, including the possibility that people who earned less had lost their jobs or marriages, or were caring for more dependents than were the people whose income had risen. The pattern held even when those factors were ruled out. These results suggest that our collective fear of losses is grounded in wisdom: losing money really hurts us more than winning money helps.

Perhaps this message sounds bleak, particularly as we begin a new year. Many New Year’s resolutions require that we embrace the prospect of paying for dieting plans, anti-smoking programs, and gym memberships—and the possibility of losing that money if our resolve wanes. (As Maria Konnikova wrote this week, many resolutions do indeed fail.)

The good news is that people can overcome their aversion to loss by thinking differently about risky decisions. One excellent technique borrows from thousands of successful stock traders. Traders make dozens of risky investment decisions every day, but they overcome the fear of losing money on any individual decision by focussing instead on those decisions in aggregate: instead of agonizing over each trade, they pay attention to the broader portfolio.

This technique, known as broad bracketing, isn’t just a mental trick; it’s actually a good way to think about life decisions. It’s unwise to focus on each financial decision in isolation when you’re constantly drawing from the same pool of funds. Instead, it is better to consider the effect of each decision on the others, and how these decisions affect you cumulatively over time. Instead of asking whether you should buy a gym membership, and then asking, separately, whether you should buy an expensive kit to help you quit smoking, you should ask whether it makes sense to buy each of those things in the context of all of your financial obligations. Perhaps you’ll squander the funds you devoted to the gym membership or the quit-smoking kit, but it’s arguably worth risking the loss given the benefits if your resolutions happen to stick—and if those investments are among a dozen such purchases, chances are that some of them will pan out. Of course, it’s foolish to think away every poor financial decision, but if you’re generally careful and prudent, there’s no reason to avoid occasional risky decisions if the potential benefits outweigh the risks.

Adam Alter is the author of “Drunk Tank Pink: And Other Unexpected Forces That Shape How We Think, Feel, and Behave,” and an assistant professor of marketing at New York University’s Stern School of Business.

Photograph by Edward Linsmier/Getty.