Loss Aversion and how it keeps us from winning.

“Loss aversion refers to the relative strength of two motives: we are driven more strongly to avoid losses than to achieve gains. Daniel Kahneman

Which would you rather receive?

1- $450,000 tax-free.

2- $1 Million dollars, but taxable, with $500,000 going to taxes.

And would it make a difference if, on the second option, you knew that 10% of the tax money was going to people or organizations that you don't think deserve it?

Both of these options are attractive, and you would think that the second one, with a net plus of $50,000 would be preferable. But that's not the case. In an online poll I did recently, it was about 50-50 between the two. Even though you get $50,000 more dollars, people just don't like losing any money or paying taxes. This is thanks to the cognitive bias of loss aversion- the preference to give more weight to losses than to gains.

When you think about it, there are only two ways to get money tax-free. (Beside some tax loopholes I'd rather not get into right now. ) Either as an inheritance when someone dies, or via criminal activity. Inheriting money involves losing a loved one, which is not the best tradeoff. And crimes are hard to justify ethically.

But earning taxable money is a good thing. Either hard work, smart investing, or dumb luck can land a person taxable money, especially a million bucks and that's the right way to do it. Unfortunately, the cost of living in a civilized society with a safety net is taxes, which means people have to pay back some of that income they never actually received.

I've been doing tax returns for clients for nearly 20 years, and no one likes to pay taxes. Many appreciate the benefits of social programs and don't mind it so much. But it sometimes seems like the ones who are doing the best in life, with the highest incomes, resent paying taxes the most. They see the loss of more money to taxes every year as a personal loss, and I have to keep reminding them that making more money every year is a good thing.

The term "loss aversion" was first coined in 1979 by psychologists Kahneman and Tversky, and has become an important part of behavioral economics ever since. Avoiding pain is an instinct that is buried deep in the human psyche, and it has caused irrational choices throughout history. In earlier times, taking a risk could mean death because the world was more dangerous. Today we know so much more about the world that risks rarely involve death, but fear of losing something still looms large. The pain that's imagined is often less than anticipated, and the pleasure that is never realized is something most of us would rather never think about.

Here are some examples of where we can be manipulated by others using loss aversion.

1- Politicians can scare voters into thinking they might lose something if the other candidate gets into office. This is why negative political advertising is so much more effective than positive ads.

2- Insurance companies make their money by using fears of disasters, death, or disease to make a sale, while paying out claims that are lower in probability than their pricing structure predicts.

3- Marketers use fake scarcity to encourage shoppers to buy things that are almost out of stock or about to go up in price. No one wants to lose out on a great deal.

4- Social media thrives on FOMO, or the fear of missing out. Users are constantly wanting to see what other people are doing, just in case others might be having more fun or success than they are. The entertainment and food industry rely on this too.

5- Few want to admit that an investment of time, energy, or money has failed. So they double down in fruitless attempts to avoid failure. They hang onto bad relationships, poor investments, or unfulfilling careers in the hopes that things might get better and they don't have to admit an embarrassing failure. This can cause a cascade of greater failures and blocks any attempts to seek out better opportunities.

What would it look like for someone to live a life without regrets or fear of failure? For one thing, they'd be willing to try out a lot more things and more likely to find the best activities to bring them joy and success. They'd be able to cut their losses and admit failure much faster while moving on hopefully with valuable lessons. And they'd be harder to manipulate. because they'd realize that opportunities arise every day.

And as for the second part of my question- would it matter if some of the money lost goes to someone or something you disapprove of? Of course this matters and is one of the most powerful political weapon there is. Politicians thrive on an us vs them mentality, and the thought that MY money is going to support THEM has caused folks to vote against their own interests for centuries. I wrote about this phenomenon, also known as the drained pool effect earlier, and you can read about that here. If we stopped worrying about punishing "them", we would likely end up happier and wealthier in the long run.

Winning is almost a religion in America. Reality shows focus hundreds of contestants into a small cadre of winners, sometimes using underhanded tactics. Politics is all about who is winning and losing, and so is dating and business. Losing is so shunned that many will do almost anything to avoid it. But it is the only way we truly learn things, and the fear of losing keeps us from growing and having empathy for others who struggle.

I'm inspired by acts like the one below, where a girl's softball team carried an injured batter around the bases after she had hit a grand slam. Even though they lost the game because of it, they did the right thing and embraced their humanity. In that respect they are far from losers.