We all know what keeps the lights on in Vegas; it’s a never-ending stream of bad risk-takers entertaining themselves by losing money at card tables, slot machines, and roulette wheels.
But the funny thing about Vegas is most people who go there don’t consider themselves gamblers. They’re just normal, everyday folks like you and me hoping to have a good time seeing a show, going to a party, or walking the strip—they’ll just do a little gambling to see what it’s all about. That’s it. Just a little.
But then they get home and realize they lost hundreds, even thousands of dollars. The problem isn’t unique to Vegas. Here’s a guy who lost his life savings trying to win an X-Box in a carnival game (don’t worry, he still won a giant banana).
But you? You don’t gamble. And if you do, you’re responsible about it, setting a limit for how much you’ll lose before you stop. What does this have to do with you?
The answer is: More than you think. And to be a truly Smart Riskologist, it’s critical you understand how and why it happens.
You see, the thing that causes people to lose their life savings at the poker table also causes everyday people like you and me to:
- Stay in bad relationships
- Dump money into businesses and investments that go nowhere
- Stick to personal projects you should have given up on ages ago
All these things happen right beneath your nose, and they hold you back. But there’s something you can do about it.
Read on to learn how to beat it.
Loss Aversion: The Reason You Don’t Act on Opportunity
Few can see it in their own lives, but scientific studies show time and time again there’s a powerful psychological phenomenon that affects most humans, and keeps you in situations you don’t want to be in. It’s called loss aversion.
You experience loss aversion when given the same choice two different ways but perceive them differently: either to gain something, or to avoid losing something equally valuable.
I could make you an offer that resulted in you making $100, or I could pose the same offer but, instead of framing it as a chance to make $100, state it as an opportunity not to miss out and lose $100.
Basically every study ever done tells me you’ll choose not to lose $100 over gaining $100.
Here’s another way of putting it. If you’re single, you might avoid situations that could cause you to end up in a relationship because you subconsciously fear losing your single identity.
Or you might talk yourself out of applying to a great job or starting a business because you have a reputation of success and don’t want to lose it if things don’t work out.
Suffice it to say, people prefer to keep things they already have than to gain things they don’t.
And this is just the beginning. If people prefer not to lose something, how do they end up gambling in the first place? And why do they continue until they’re broke?
Sunk Cost Fallacy: The Reason You Stay When You Know You Shouldn’t
In some circumstances, loss aversion is a good thing—it keeps you from making truly bad decisions like investing all your money in a tech company with no earning potential or cheating on your spouse. But when it steers you wrong, it steers you very wrong.
If you make a mistake and commit yourself to something you shouldn’t, loss aversion can take hold in an even bigger way that makes you stick to the plan even when the plan is all wrong.
This is called the sunk cost fallacy.
What happens is that, by making a bad commitment, you’re more likely to stick to that commitment in an attempt to recover your lost time/money/energy/etc. even if the more logical choice is to stop everything and start over.
The sunk cost fallacy is a powerful force. Its how people end up in deadend jobs for a lifetime. They make a mistake picking a career and, rather than correcting it, they spend 30 years or more trying to compensate. The same is true for relationships. Rather than cutting off a bad one, you often invest even further, hoping to fix it when the only real solution is to start over.
How Our Unfortunate Friend Accidentally Bought a $2,600 Banana
The sunk cost fallacy is exactly what caused our unfortunate friend from the beginning of this piece to lose his life savings over an Xbox. He made the initial mistake of gambling because of the way the game was marketed: “Win an Xbox for $3.”
With odds seeming so far in his favor (despite them never actually being favorable at all), he made what seemed like a rational choice: Risk $3 for a chance to win something worth $500. Loss aversion didn’t kick in because the choices didn’t seem equal. There was little to lose and lots to gain.
But that very first gamble started a chain reaction between loss aversion and its successor—the sunk cost fallacy—creating a feedback loop where each fed off the other until he was ruined.
With $3 lost, there was still more to lose before it wouldn’t make sense to keep gambling on an Xbox. The odds still seemed favorable.
But suddenly, a few hundred dollars are gone, and the sunk cost fallacy sets in. He continues to gamble, but it’s no longer about the Xbox. That’s what started it all, but now he just wants to get his $300 back. So he goes to a bank and gets the rest of his money. He goes back to the game table and starts playing double or nothing. If he wins just a few times, he’ll get his money back.
But the game is rigged—or at least extremely unfavorable—and the money is gone.
How could he have avoided this situation in the first place?
Beating Loss Aversion: How to Become an All Star Risk-Taker
You’re a Smart Riskologist, so it’s unlikely you’ll ever end up in a situation where you’re putting your life savings on the line for an Xbox, but certainly you can think of a time when you invested way too much of your resources into something you knew you shouldn’t have.
Maybe you can even think of something now. Here are a few things you can do to avoid becoming a victim of your own psychological habits.
1. Quantify the real loss.
Loss aversion kicks in because it’s a bias that weighs loss heavier than gains, even when they’re the same. That’s like saying you can put two identical objects on a scale but see different weights. You could draw a comparison to anorexia—where someone continues to lose weight far past any healthy standard, yet they see a fat person even as a skeleton stares back at them through the mirror.
I don’t know how to beat anorexia, but I know beating loss aversion in your everyday life means finding ways to assess how big a loss really is when you feel like it may be tremendous.
A good way to do this is to compare the loss to a gain.
Earlier, I mentioned most people see losing $100 as a bigger deal than gaining $100. In reality, they’re the same. And the way to see that is to ask yourself two questions:
- How would my life change if I lost $100?
- How would my life change if I gained $100?
Anchoring the different sides to something more tangible in your mind will help you see a gain or a loss for what it really is.
2. Focus on success in the future instead of failure in the past.
I was listening to NPR the other day, and Shankar Vedantam made a great analogy that applies perfectly to beating this psychological disadvantage:
Making decisions from a perspective of loss aversion is like driving a car by looking through the rearview mirror. If you wouldn’t drive your car by looking backward at where you’ve already been, why would you direct your life that way?
When you feel the sunk cost fallacy kicking in and find yourself rationalizing what you know is a bad decision just to keep something from your past, it’s time to check yourself!
Ask yourself, “Where is it I really want to head?” If the answer is not where you’re headed now, you know the sunk cost fallacy is directing your life and you need to look at things from a perspective of moving forward.
3. Take frequent breaks to assess where you’re actually at.
The real reason our friend with the $2,600 banana ended up in misfortune is because he got caught up in the moment and allowed his emotions—fully vulnerable to all kinds of psychological disadvantages—steer his decision-making.
If, instead, he’d taken a moment to cool down and think about the situation he was in, he would have made the smart decision to accept his loss and move on with some resources still available to him (while he still had plenty to move on with).
Any time you find yourself making panicked decisions, it’s a sign loss aversion is taking over and you need to remove yourself from the situation, take a break, and allow yourself to assess where you’re really at.
You’ll make far better decisions.
Your Homework Today
You probably won’t ever find yourself choosing between paying your rent or buying a $2,600 stuffed banana, but the lesson here can be applied to your life regularly—often to decisions you make every day.
Today, take a minute to figure out where loss aversion could be affecting the choices you’re making for your life, and follow the three tips above to start looking at those decisions from a new perspective.
Remember: Smart Riskology means racking up lots of little wins over the long-term. True success is measured in years and decades, not days and weeks. Make decisions accordingly!
Yours in risk-taking,