Avoiding Your Own Loss Aversion

Statistics indicate that the majority of people are security conscious. This fact has been verified in a number of studies which concluded that many people people’s fear of failure is twice as great as their desire to succeed. Some of these studies also noted that in general, there will be up to 5 times as many people choosing a stable situation than people choosing an option with recognized risk. In order to achieve FF (Financial Freedom) you cannot be afraid to fail or take a risk.

Our tendency to avoid risk is known as loss aversion. It means a person believes that if they lose something, say $50, their level of unhappiness with that loss will be significantly greater than the potential increase in happiness if they gain $50.  Its apparent in our everyday lives. People will order the same thing off the menu every time simply because they are afraid they might not like what they order if they try something new, even when there is a good chance they could find a new favorite. Similarly, people put their money in low interest bearing savings accounts rather than put any of it some kind of investment account that will most likely make them significantly more in interest, primarily because there is some chance of loss. So it sits in the banks making next to nothing.

The problem may come down to a belief that one has no control over the outcome of their circumstances, be it their food or their investments. A class of Harvard graduates was asked what they believed were the necessary ingredients to become financially successful.  Their conclusion was summed up in two words, “Greed, and Luck.” I couldn’t disagree more.

If you consider the statistics I mentioned, you might very well conclude that only one out of five people will ever have FF. But that is just a statistic and has no bearing on what YOU will achieve. You can decide to take the risk and be that much closer to FF. Next week I will talk more about risk taking and what you as an investor need to understand about yourself.