We are more sensitive to loss than we are to the equivalent gain. In a simple way to put it, we feel more pain in loosing 100rs than feeling happy in gaining 100rs. This behaviour is termed as Loss Aversion in behavioural economy.
While this cognitive bias of ours is exploited by many fields including insurance, marketing etc day to day, on a personal level, it affects the finance related decisions we make too. The main implication is being “risk averse”, we tend to take fewer or no risks at all, fearing the potential loss.
How can we avoid being risk averse and use our rational judgement in our decisions to overcome this bias while managing our finance?
1. Have a plan- A vintage but rarely followed advice
A thorough exercise of writing down your financial goals on a paper by committing to muscle memory with a map of where you are now and how to get to your goals will seriously help. This is of course not set on the stone and you can modify it as you go. Having a plan reduces anxiety. With less anxiety, you feel more positive emotions in general and you are more optimistic about the future. Positive and optimistic people tend to be less risk averse.
2. Secure your family and assets -Know that your loved ones are taken care of
If I were to die tomorrow in an accident, would my family or people who are dependent on me suffer financially? Take actions immediately if your answer is yes. For example you could start from taking a good term insurance and life insurance to secure your family in any unfortunate events.
What are your assets? List all of them that will make an impact on your life in case you lose it. Let's say you own a house, a car and some precious jewels, then taking a house insurance or theft insurance would be a good idea.
Your fear of loss tends to be higher if the loss affects someone else you love. The preparedness in reducing the probability of losses will boost your attitude for risk taking.
3. Have a pile of money that you can bet and lose
Honestly I would have lost many opportunities because simply I didn't have an understanding of how much I can afford to lose. It doesn't matter how much money you make, but simply putting away some cash will go a long way in pushing you to make that decision fast, be it a call to start your own business that you are passionate about, or a golden opportunity for your ideal investment.
4. Accept losses as a part of the game
Over 10 million new investors entered the Indian stock market in 2020. Out of this chunk, some handful investors will quit the stock market after experiencing their first loss, giving up their long term gains. If you have invested in 10 stocks after doing your due diligence and research, you still have to be prepared for 4 stocks to fail. Your rest of the portfolio might do exceptionally well and you could average it out at the end.
So, let's risk it!