Hey everyone, welcome back.
Today we're going deep on something that might be secretly messing with your retirement plans.
Oh, tell me more.
It's all about loss aversion.
We're checking out this video from Tutor2U on YouTube about how this sneaky psychological
bias can really mess with our investment decisions, especially when it comes to saving for those
golden years.
Interesting.
I'm all ears.
Okay, so let me ask you this.
Would you be more stoked about finding a 20-pound note just lying on the street, or would you
be more relieved about not losing a 20-pound note you already have?
I think probably not losing the money I already have, avoiding that loss for sure.
Most people feel that way.
Makes sense.
The pain of losing that money just kind of stings more.
That's loss aversion in action.
So it's like this built-in thing where our brains are wired to really zero in on potential
losses?
That's this quirk, right, where the pain of losing something feels so much stronger than
the pleasure of gaining the same amount.
Wow.
So our brains are kind of playing tricks on us when it comes to risk.
Totally.
I just showed just how powerful this bias can be.
This Tutor2U video uses a coin toss example.
Like imagine you could lose 50 quid on a coin toss.
Okay, I'm listening.
How much would you need to win to make that bet even worth considering?
Ooh, good question.
Probably at least 100, maybe even more, I have to think about it.
Most people say they'd need to win at least double, maybe even more to even think about
taking that risk.
Makes sense.
You don't want to lose your money.
Right.
And what's fascinating is this isn't just about the numbers themselves, it's about
how we think about them.
And that's where things get a little mind-bendy with this concept called prospect theory.
Prospect theory sounds intense.
It is.
It's developed by these behavioral economics rock stars, Kahneman and Traversky.
Okay, I'm intrigued.
What's the gist?
So prospect theory basically shows that we're not always the most rational thinkers when
it comes to probabilities.
We tend to overestimate the chances of small probabilities like winning the lottery, but
then we kind of underestimate medium probabilities.
Oh, so we get all excited about small chances of hitting it big.
Yep.
But we're not so great at accurately assessing more likely outcomes.
Gotcha.
So is that where the coin toss comes in?
Exactly.
They use this example where you've got to choose between two options.
They both involve winning some money, but in different ways.
Okay, I'm following.
Lay it on me.
Option A is like a gamble, right?
You have a chance to win two grand, 1120 pounds or nothing at all.
So there's a risk involved, huh?
Yep.
But then option B is like a sure thing.
You get a guaranteed payout of 19, 20 pounds.
Hmm.
So less money, but guaranteed.
Tough choice.
Right.
So the thing is that most people pick the guaranteed cash, even though if you actually
crunch the numbers, option A, the gamble has a higher expected value overall.
Really?
So we're letting our fear of getting nothing at all outweigh the potential of winning even
more.
It's like we're so scared of ending up with nothing that we miss out on the chance of
potentially winning bigger.
Makes you think, doesn't it?
But how does this connect back to pensions and investments?
Right.
Because those aren't like coin tosses.
Well, actually, this is where loss aversion can really trip us up when it comes to planning
for retirement because you see, it plays out in the real world all the time, especially
in how we act in financial markets.
So like give us some real world examples.
How does this whole fear of loss thing show up when we're making investment decisions?
Okay, think about it.
Have you ever held onto a stock, you know, when it was losing money for way too long
hoping it would magically rebound?
Yeah, definitely guilty of that.
Or maybe sold an investment too early, even though it was doing well because you were
afraid of it suddenly tanking.
Okay, yeah, I've done that too.
So is that loss aversion in action?
100%.
We're so averse to like admitting we made a mistake, you know, that we cling to those
sinking ships hoping things will turn around.
Makes sense.
And then on the flip side, we bail on winning investments because we're terrified of seeing
those gains disappear.
So our fear of loss could actually be stopping us from like maximizing our returns, especially
with long term investments like pensions.
Exactly.
And when you consider pensions, which are all about long term growth, that kind of short
term fear driven thinking can be really bad for your retirement savings.
It's like we're letting emotions get in the way of making smart decisions about our financial
future.
It happens all the time.
And when it comes to something as important as your retirement security, you really want
to make sure you're making decisions based on, you know, sound financial principles,
not just gut feelings.
So how do we outsmart this whole loss aversion Gremlin?
I mean, are there any ways to beat this bias and make more rational investment choices,
especially when it comes to pensions?
Absolutely.
There are some really smart ways to handle this.
One of the most fascinating examples is something called the Save More Tomorrow Plan developed
by this brilliant behavioral economist named Richard Thaler.
It's a perfect example of using psychology to actually nudge people towards better financial
behavior.
Okay, so tell me more about this Save More Tomorrow Plan.
It sounds like it could be a game changer.
It's incredibly clever.
So basically, your contributions to your pension are only taken out when you get a pay raise.
That way, you never actually see a decrease in your take home pay.
Oh, that's smart.
So we never feel the loss because we're only contributing money we didn't have before.
Precisely.
It's like a sneaky way to sidestep loss aversion altogether.
The results have been pretty amazing.
People who participate in Save More Tomorrow Plans end up saving way more for retirement.
That's incredible.
So even though loss aversion can feel like this powerful force holding us back, there
are ways to outsmart it.
Absolutely.
It's almost like we can design systems that work with our psychology, not against it.
That's the key.
And it reminds us that we're not just slaves to our biases, you know.
With a little understanding and clever design, we can actually nudge ourselves towards making
better financial decisions.
This is seriously eye-opening.
We've uncovered how loss aversion can mess with our investment choices, but also how
strategies like the Save More Tomorrow Plan can help us overcome it.
But don't go anywhere.
When we come back, we'll keep exploring the world of loss aversion and how it affects
our financial well-being.
Welcome back to our deep dive into loss aversion.
We're going to keep digging into how this sneaky psychological bias can affect our financial
well-being, especially when it comes to long-term goals like retirement.
Yeah.
I'm already starting to look at my own financial decisions differently after that last part.
So before, we were talking about how understanding loss aversion can help us make smarter choices
about our pension savings.
But I'm curious, how does this play out day to day when we're managing our investments?
That's where things get really interesting.
This loss aversion can make us do some pretty counter-product stuff, especially when the
market takes a dip.
When stock prices drop, our gut reaction is often to sell, sell, sell.
Oh, I know that feeling.
It's like watching your money disappear and your brain is screaming at you to do something,
anything to stop it.
Exactly.
But the important thing to remember is that those short-term market swings are totally
normal and reacting impulsively can actually hurt your returns in the long run.
So don't panic and sell everything when the market drops.
Right.
Think of it like this.
When you plant a seed, you don't dig it up every few days to see if it's growing.
That's a great analogy.
You got to give it time to take root.
Exactly.
And it's the same with investments.
Those short-term dips are like, ah, little storms, they come and go.
What really matters is the overall trend over time, and historically, the market tends to
go up.
So the key takeaway is to stay focused on the long game.
Don't freak out and sell when things get shaky.
You got it.
And that's where having a solid investment strategy is crucial.
A good strategy can help you ride out those bumps.
By diversifying your portfolio, you can spread your risk and make the impact of any losses
smaller.
It's like having a safety net for your investments.
Diversification.
I hear that word all the time, but honestly, I don't really get what it means in practice.
Sure.
It just means not putting all your eggs in one basket.
Instead of putting all your money in one stock or one type of asset, you spread it across
different investments like stocks, bonds, real estate, even things like precious metals.
That way, if one investment takes a hit, the others can kind of cushion the blow.
Oh, I see.
So if one part of your portfolio is doing bad, another part might be doing well, and
that helps to even things out.
Precisely.
And the great thing about diversification is that it helps you manage risk without necessarily
giving up potential returns.
There are actually a lot of tools and resources out there to help you build a diversified
portfolio that matches your risk tolerance and your goals.
So are there any resources you'd recommend?
A lot of people, including me, feel intimidated by investing.
It's like we need to learn a whole new language.
It can definitely seem that way.
But don't worry.
There are a ton of options available to help you navigate the world of investing, even
if you're not an expert.
If you're comfortable doing some research yourself, there are loads of online platforms
and apps with tons of information, from educational materials to investment analysis tools.
So there's stuff out there for people who want to manage their own investments.
But what about people who prefer a little more guidance?
That's where financial advisors can be super helpful.
They can work with you one-on-one to create a personalized investment plan.
It'll be tailored to your specific needs, risk tolerance, and goals.
Think of them as your financial sherpa guiding you through the whole thing.
A financial sherpa.
I love that.
So whether you're a seasoned investor or just starting out, there's help available
to make smart decisions about your financial future.
Exactly.
And remember, it's never too early or too late to start planning for your financial
well-being.
This has been so helpful.
I feel like I'm starting to wrap my head around this whole loss aversion thing and
how it can affect our financial decisions.
Me too.
It's definitely something to keep in mind as we navigate the world of investing and
plan for our future.
Absolutely.
So we've explored the downsides of loss aversion, but also how to outsmart it and even use it
to our advantage.
We've uncovered so much about how our brains work when it comes to money, especially this
thing called loss aversion.
Yeah.
It's amazing how these little quirks in our psychology can really influence our financial
decisions.
Totally.
Before, we talked about all the resources out there for investors, whether we want to
go DIY or work with an advisor.
Right.
We have great options available these days.
But as we wrap up our loss aversion deep dive, I'm wondering, is there like a silver lining
to all this?
I mean, we've talked about how this bias can work against us, but are there any times
when loss aversion could actually be a good thing for our finances?
That's a really interesting question.
And honestly, it's something I've been thinking about too.
While loss aversion can definitely lead us astray, there are situations where it can
actually motivate us to make positive changes.
Like, have you ever heard of those commitment devices people use to achieve their goals?
You mean like signing up for a marathon to force yourself to train?
Or putting money on the line if you don't stick to a new habit?
Exactly.
Those are perfect examples of using loss aversion to our advantage.
By framing things in terms of potential losses, we create a much stronger incentive to actually
follow through.
So it's like tricking our brains into doing the right thing, turning that fear of losing
into a tool.
Exactly.
The fear of losing money or even facing embarrassment can be a super powerful motivator.
It helps us overcome inertia and stay focused on those goals.
This deep dive has been a real eye-opener.
We've seen the dark side of loss aversion and how it can sabotage our financial well-being.
But we've also found ways to outsmart it and even use it to help us.
Knowledge is power, right?
By understanding the influence of this bias, we can make more intentional choices about
our money and our future.
Couldn't agree more.
So as we wrap things up, I want to leave our listeners with a final thought.
Knowing all this about loss aversion now, what's one small change you can make today
to improve your long-term financial well-being?
Maybe it's setting up automatic contributions to your pension, finally letting go of that
investment that's been dragging you down.
Or even just shifting your perspective, you know, focusing on long-term growth rather than
getting caught up in the day-to-day ups and downs of the market.
Time is on your side.
Great point.
Even small changes can make a big difference over time.
Thanks for joining us on this journey into the world of behavioral economics and the
power of loss aversion.
We hope this has given you some valuable insights to help you navigate your financial journey.
It's been a pleasure.
Until next time, keep learning, exploring, and diving deep.