ShortchangedbyShortcuts?

Shortchanged by Shortcuts?

If you were offered a 95% chance of winning $10,000 or a 100% chance of winning $9,000, most people would choose the sure thing, even though statistically it’s a worse deal.

However, if the prospects were reversed and you were told you had a 95% chance of losing $10,000 or a 100% chance of losing $9,000 most people would take the chance.

Prospect Theory dictates that when it comes to potential gains, people are, by default, risk adverse. When it comes to avoiding potential losses, however, people become, by default, risk seeking.

The fact that we will take greater risks to avoid losses is the heart of what’s commonly known as loss aversion. Winning may make us happy but losing makes us miserable. We’re much quicker to feel bad about loss than we would be to feel good about gain. There’s a demonstrable asymmetry in our behavior when it comes to going for gains vs. avoiding losses. Prospect Theory calculates this roughly as a 2.5 times difference. In other words, experiments have shown we need to win $250 to feel as good as losing $100 makes us feel bad.

This shortcut has enormous implications in, among other things, our buying or selling our homes. For one thing, it makes no rational sense. When it comes to avoiding losses, you and I become irrationally risky. Our responses differ from statistically appropriate responses, creating more risk of loss not less. In other words, when faced with the risk of losing money, we tend to take actions that will increase the chance of losing more money.

Look at another experiment, conducted by noted behavioral economist, Dan Ariely: • Salespeople were paid a commission to sell TVs. • TV manufacturer “A” paid the commission up front.

That is, salespeople were given the total possible commission for selling all of “A’s” TVs before they had even sold a single one.

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