How Fear of Loss is Holding You Back Financially
Fearing loss is an instinct that helps species survival, but is it harming your finances?
Have you ever been walking down the street and found a $20 bill lying on the ground?
You get a rush of dopamine at finding something unexpected and exciting.
Pretty great right? Free money!
But, have you ever lost a $20 bill?
You search every pocket 10 times, but it’s just… gone.
You feel awful. Horrible. No good. Very bad.
HOW could you possibly lose that $20??
What is loss aversion?
The reason you feel so much worse when you lose the $20, than when you find $20 is because of loss aversion.
Loss aversion: people tend to prefer avoiding losses to acquiring gains.
Loss aversion is a term from behavioral economics, describing how we tend to prefer avoiding losses to acquiring gains. In other words, the pain of losing something is greater than the pleasure of gaining something.
For example, if I gave you $1,000 you would feel really happy! But if you lost $1,000 you would feel absolutely awful.
Where does loss aversion come from?
We can link our loss aversion back to evolutionary survival instincts.
We are programmed to feel pain from loss as a way to help the species survive. Losing food, shelter or water could mean death, whereas potential gains - like finding extra food - while helpful, isn’t always necessary for immediate survival.
This has made us hardwired to avoid losses before pursuing gains.
What’s more, the amygdala - which is our brain’s control center for emotions - activates more strongly when expecting losses than it does for expecting gains. This proves that even our brains want us to avoid losses at all costs.
How does this affect our financial behavior?
Risk avoidance
Fear of loss will cause us to avoid risk, even when the potential gains outweigh the potential losses. It’s an illogical pattern, but driven by our emotions.
With your money, this may lead you to avoid investing in the stock market for fear of losing money, even if you know logically that investing is an important part of growing wealth.
It also could mean not trying to negotiate your salary at work, for fear of losing the job you have or damaging your relationship with your current employer. So, you settle for a lower salary effectively “losing” potential income.
Analysis paralysis
Similar to risk avoidance, fear of making the wrong decision can lead to inaction.
Making NO decision can often lead to worse consequences than the wrong decision.
You know that you should be investing for retirement, but you are terrified of choosing a bad stock so instead you choose…nothing.
Analysis paralysis can be dangerous because lack of action can sometimes lead to even worse consequences than making the wrong decision.
For instance, if you choose a bad stock when investing you may only get 2-3% returns instead of the average 8%. But choosing nothing means you get a 0% return. This is even worse than making a bad stock choice.
Your fear of making a poor decision has led to even worse outcomes.
This could also be procrastinating on home repairs. If a pipe is leaking, but you choose to ignore the problem because you don’t know a plumber to call, it could later turn into major water damage, costing far more than a leaking pipe.
Hoarding behaviors
Finally, fear of losing money can cause us to cling to it even tighter.
For example, if you constantly save your money out of fear of something unexpected, you are wasting opportunities to use your money in better ways.
Of course, saving money in an emergency fund is important, but there is a point when you have enough. Saving money for the sake of saving isn’t a productive use of money.
Hoarding comes from a need to control. It provides us with a feeling of security in uncertain circumstances. But, ultimately, it will lead to negative outcomes like: not investing for the future, sacrificing spending on things that bring you joy, not spending on personal development - like education or career advancement - and your cash losing value over time due to inflation.
How to overcome loss aversion
1. Reframe your mindset
Loss aversion is strongly linked to fear. To shift your perspective, focus on gains over losses.
You could lose money on the stock market short term, but over the long term you are guaranteed to make money. Rather than focusing on the potential losses, focus on the potential gains.
Try these reframes:
Investing is scary, but it will help me retire one day.
Negotiating my salary is hard, but it will help me reach my financial goals faster.
My financial decisions are learning opportunities, not potential failures.
Practice focusing on the positive aspects of your financial decisions, not dwelling on the negative.
2. Embrace the data
I firmly believe that money is 80% psychological and 20% numbers.
That’s exactly why it’s so important to pay attention to the numbers. They provide a rational counterweight to the emotions driving our decisions.
When you know the facts - like you are 100% guaranteed to make money in the stock market over any 20 year period - it helps make scary decisions feel more logical.
Do some research so you understand the facts before making a financial decision. The more you understand the numbers, the less power loss aversion holds over you.
3. Practice gradual exposure
Start small and build your confidence.
If investing is scary, start by just investing $20. You can watch how the stock market moves up and down for a while, then slowly begin investing more as you feel comfortable.
The more you practice letting go of loss aversion, the easier it will become.
Loss aversion is a natural human instinct, but it doesn't have to control your financial decisions. By understanding how our innate psychology affects our daily lives, you can learn to make more rational choices with your money. Awareness is the first step.
Your life may not be perfect, but it is imperfectly yours. The only way to live it is your way.
Katherine, founder of Imperfect Budget
Imperfect Budget is an educational platform built to help women align financial goals and free themselves from limiting money mindsets.
Want to know your money personality?
Take my FREE quiz to find out!
