Imagine you’re in Las Vegas. You walk into the casino, play a blackjack game, and win $1,000. Feels pretty good, right? But imagine the devastation of losing $1,000.
For most of us, the feeling of losing money is enough to avoid playing blackjack altogether — even if there is an opportunity to gain money. This is because humans are susceptible to a cognitive bias called loss aversion.
What is Loss Aversion?
Loss aversion refers to the tendency to avoid activities with even a slight chance of adverse outcomes. It is a critical concept in psychology and economics, and it helps to explain why people are often unwilling to take risks, even when the potential rewards are high.
In financial terms, loss aversion leads people to prefer guaranteed money (like savings accounts) over money that could potentially lose value (like stocks). This is because the psychological pain of losing money is greater than the pleasure of gaining money.
In other words, people are more motivated by avoiding losses than by achieving gains. As a result, loss aversion can lead people to make financial decisions that are not always in their best interests. However, understanding loss aversion can help you make better choices by considering your natural tendencies toward caution.
How to Overcome Loss Aversion in Your Financial Life
While it can be challenging to reframe your psychology towards money and risk, there are a few ways to overcome loss aversion in your financial life.
Take On “Safe” Financial Risks
First, it’s essential to understand that not all risks are equal. Some risks, like investing in a diversified portfolio, are relatively low. These low-risk investments are a good way to grow your wealth without having to worry too much about the prospect of losing money.
But some investments are more volatile than others (such as investing in cryptocurrency). So instead of aiming for the amount you can gain in a short window, seek to make small amounts over a longer period.
And remember—sometimes, the risk of not making a money move costs you more in the long run. Switching jobs, for example, can seem risky, but you’re far more likely to prosper if you change jobs every few years than if you stay in the same position and hope for a raise each year.
Re-frame Risk as Opportunity for Luck
When it comes time to make financial decisions, try to think about the potential upside rather than focusing on the potential for loss, for example, think about how much you stand to gain by investing.
Keep the long-term gains front-and-center in your mind in other areas of your life rather than getting hung up on initial costs. Relocating to a city with more job opportunities might be costly upfront, but you’ll likely have a higher-paying job and a more diverse array of opportunities.
Adopt an Abundance Mindset
While it may be easier said than done, remember that money will always come and go, but there is always more money to be made. An abundance mindset will help you uncouple the fear of loss from your financial choices.
Try to recognize feelings of loss aversion when you are making financial decisions. Knowing your reactions can help you manage them so you can make goal-directed, intentional choices with your money.
Final Thoughts on Loss Aversion
Shifting your mindset is no easy feat, but by taking these steps, you can start to overcome your psychological aversion to loss and make sound financial decisions that will help you build long-term wealth. While it’s normal to be cautious of risk, remember that informed risk is critical to growing your wealth. Understanding the psychology behind your approach to finances is critical to your economic success.
Need more support? Julep pairs psychology with financial management techniques to help you change your money mindset.
Julep is not a financial institution, financial advisor, or credit repair company, and does not provide credit repair services of any kind. The information provided is for general educational and reference purposes only. The information is not intended to provide legal, tax, or financial advice. We do not propose any guarantee that the information provided will repair or improve your financial profile. Consult the services of a competent licensed professional when You need financial assistance.