Decisions regarding the management of our money are not dictated exclusively by numbers, technical information, and rationality.
In fact, even without being aware of it, emotions play a crucial role and significantly influence our choices.
Among the cognitive distortions (biases) that can affect our behavior when it comes to money, we find the loss aversion bias.
Let’s see exactly what this bias is and why it has such a strong impact on our financial choices.
What Is the Loss Aversion Bias?
The loss aversion bias is a concept introduced by psychologists Daniel Kahneman and Amos Tversky, the fathers of behavioral economics. According to this bias, also known as Deprivation Syndrome, we hate losing something we have more than we enjoy gaining something we don’t have. In simple terms, we hate losing more than we love winning.
This happens because the psychological pain of a loss is perceived as more intense than the joy of an equivalent gain. In practical terms, losing €100 causes us more psychological pain than the happiness we feel from gaining the same amount.
This explains why investors often overreact to losses, trying to mitigate the damage with irrational decisions that end up causing even greater losses.
Why and How Does It Affect Us?
The main reason we are influenced by the loss aversion bias lies in the evolutionary and psychological roots of human behavior.
From an evolutionary perspective, avoiding losses (for example, of essential resources) was crucial for survival. This tendency has therefore become ingrained in our brains, unconsciously influencing our daily decisions, including financial ones.
Moreover, losses are typically experienced as personal failures and can compromise our self-esteem and decision-making abilities.
This bias can therefore represent an obstacle to the rational management of money. An uncontrollable fear of losing money can fuel a fear of investing; however, this behavior limits the possibility of improving our financial situation due to excessive caution. In fact, the fear of seeing even small amounts of our money disappear risks causing us to miss out on significant economic returns that we could achieve through well-thought-out investments.
How to Mitigate the Impact of the Loss Aversion Bias
It can be mitigated through better financial education, which, in addition to teaching us how to plan and manage money in the long term, provides us with the basic knowledge to better understand the advice of specialists we consult for investment guidance.
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