No man was ever wise by chance
Lucius Annaeus Seneca
Understanding humans are risk-aversion is probably the most important lesson in behavioural economics. Here below is a post that should most privately help you deal with economic risks in the best fashion:
Risk Aversion and its basic implications
Due to various biological and evolutionary advantages, we are roughly 2.5 times more sensitive to losses than we are to gains of similar size (on average, exceptions to the rule surely exist). As you can see, life is hardly a happy affair in that case when sabotage is rife and competition fierce. Moreover, when people lose everything (financially-wise) - be it due to physical health, mental-health, war, legal corruption, hyper-inflation or great recessions, poor individual decisions or just sheer bad luck - well then life is down-right anti-humane. First and foremost, that needs to be understood. Beyond financially, a huge part of life is coming to terms with death, illnesses and accidents which lead to loss through proper grieving and when people lose loved ones or get seriously harmed, then materialist compensation will rarely be enough. Reducing humans to economic numbers is a practice of the worst utilitarian vision.
However, from a psychological side, there are decent reasons why people suffer more from losses than they gain enjoyment from similar gains. This character trait makes us more empathetic - we all have to experience the shared injustice in a way and that in turn makes us less ruthless and more compassionate to one another. There's a reason why it is a sign of advancement that now society in most passionate about games, which in reality are trivial - like football, as opposed to gladiator fights. Above all losses particularly hurt due to evolution, since it makes people safer (being risk-averse means we get less eaten by lions metaphorically speaking.)
Unfortunately, on a micro-scale, it is why we can so easily be exploited by insurance companies and why we often lack bravery, ambition and don't take risks when they are rationally worth taking. What's the main advantage to knowing that this is how we are wired? Primarily, so we can acknowledge at times we are overly-fearful and at other times, so that we can work on our grieving skills, know that our emotions aren't rational and that therefore, we need more caution. Once this point is sunk in, we can know that no 50/50 financial decision really feels like a 50/50 emotional decision, but more like a 25/75 decision (with 25 being the chances of gain). Only the most brave therefore and most capable of handling losses should take more of what feels like 50/50 financial decisions, otherwise the potential for emotional destruction will be too great.
What's the main disadvantage (so to speak - from an ethical standpoint and only to ourselves) of knowing that we suffer from loss more than when we gain? Primarily, once known, our consciousness is greater and the old ethos shared among every religious movement - to treat your neighbor as you would like to be treated yourself - becomes far more relevant, makes far more sense and also becomes more complex to follow. Why? Well, it becomes clear that when you make a decision which gives you a gain at someone-else's expense that that gain ought to be much larger to you than their loss is to them (all other things being equal) for you to ever have any justification to make the decision; otherwise you are creating great suffering. Corporations may train people otherwise, especially when it comes to making redundancies so that there are bigger executive bonuses, but that is the truth.
Rationally, this means if your gain equates to someone-else's loss or even if it is bigger than their loss, you probably should not make the decision in your best interest, unless their loss is extremely minimal, because it would be oddly still too selfish. This is counter-intuitive, hard and seemingly unfair but it is true. If you face a prisoner's dilemma where you being selfish gives you 22 and the other -8, and you being co-operative gives you 5 and the other 5 and you know that they will be co-operative and are expecting 5, then the worst choice is still taking 22 even though your gain from that choice (17) would be considerably greater than their loss (of -8). It seems selfless and stupid, but it is the emotionally smarter choice, once you factor in the emotional cost of losing (x2.5). The pain of loss needs to be respected. Our emotions aren't always correct.
Risk Aversion - Prospect theory
This theory, originally developed by Amos Tversky and Daniel Kahneman (author of 'Thinking, Fast and Slow' ) shows that losses and gains hurt and reward less the further the go from our expectations proportionally meaning in general, loss aversion favors stability over change.
People view gains and losses relative to a reference point, which is usually their current situation. Imagine two identical twins who find two alternative environments equally attractive. Imagine further that by force of circumstance the twins are separated and placed one each in the two environments, and the environments turn out exactly as they expected but neither know how their twin viewed the other environment. Due to the fact people prefer stability, now both twins would be expected to be unhappy if they were forced to change their environment, they no longer would have a neutral preference (not talking about the hassle of the change). Again this is an evolutionary trait, the combination of adaptation and loss aversion provides limited protection against regret and envy by reducing the attractiveness of foregone alternatives and of others’ endowment, however irrational this may be - it is a blessing in disguise.
However, prospect theory adds more nuances to this reality. Due to the fact losses hurt less the further you go from your reference point (expectations) prospect theory shows that people will be more likely to take risks when they are experiencing losses than when they are experiencing gains. The closer you are to level of expectation, the more likely you are to take actions that minimize losses and avoid actions that could lead to losses. The further a person is from expectations and in the realm of losses, the much more likely the individual is to take risks in order to recoup previous losses or to recover from a loss in order to revert to a previous position. Bear this in mind, next time you judge gambling addicts who seemed to gamble at the very worst times in their lives to do so, as what seems shocking to the stable individual may be sadly just human.
Risk Aversion - Framing
It is known, the same people might be risk-taking when they are pretty certain of a small loss but feel there is a small chance of a gain (e.g. when buying a lottery ticket) and risk-averse when when they feel they can protect against an unlikely chance of a big loss by making instead a sure loss (e.g. insurance). In both instance people are overrating small-probability events, after all both the lottery and insurance companies end up on average in profit. However, this same mental profile shows how the framing of an issue changes so much a person's reactions to it (whether to focus on the positives or negatives of a decision). If a person is told to quit smoking so that they can surely enjoy better health, they will be less motivated to quit than if a person is told to quit because they could (though unlikely) get lung-cancer and even die as a result.
In one study by Tversky and Kahneman, roughly a third of participants rejected choice A but accepted choice B when presented with two lottery options -
A- 'Would you accept a gamble that offers a 10% chance to win $95 and a 90% chance to lose $5?'
B- 'Would you pay $5 to participate in a lottery that offers a 10% chance to win $100 and a 90% chance to win nothing?'
Kahneman concluded 'Thinking of the $5 as a payment makes the venture more acceptable than thinking of the same amount as a loss.'
Equally, if a government debates going to war or implementing measures against a disease (e.g. corona-virsu) and the government explains that x amounts of lives will be saved as a result, they will get a very different response to if they explain y amounts of lives will die as a cost of their decision, so the government can effectively manipulate the public by deciding whether to talk about the costs or benefits for that war or safety measure, in the most simple way.
Another survey by Kahneman asked subjects to imagine preparing for the outbreak of a disease which is expected to kill 600 people and divided them into two groups who each would choose one of two regimes to combat the disease.
The first group is told that the options are a regime whereby 200 people will be saved, or one in which there is a 1/3 probability that 600 people will be saved, and a 2/3 probability that no people will be saved. Under these circumstances, 72 % of participants preferred the first regime, only 28% the second.
The other group is told that the options are a program whereby 400 people will die, and one in which there is a 1/3 probability that nobody will die, and a 2/3 probability that 600 people will die. In this situation, 78% preferred the second program, only 22% opting for the first, despite their options being the same as the first group.
Hence, if a cleaning product claims to "kill 95% of all germs" and another claims - “only 5% of germs survive", people will choose the former. Most pertinently this shows that patients suffering from cancer may make different choices of whether to undergo surgery or chemotherapy for treatment of their illness based on whether the outcome percentages were presented in terms of survival or mortality. At the very least this shows it's important knowing that things may be framed a certain way in order for us to be manipulated to act a certain way, so we should consider our options by framing them in all the angles they can be first, before making a choice. The only solution to framing is to not do it to one side of an argument.
References
(1) Thinking fast and slow, Daniel Kahneman, 2012
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