Loss Aversion

Recently I was listening to Sam Harris’ podcast, ‘Making Sense’, with guest Daniel Kahneman.

Kahneman is a Nobel Prize winning psychologist and author of the hugely popular book, ‘Thinking Fast and Slow’. His niche is cognitive biases.

Loss aversion is a cognitive bias that suggests that for individuals, the pain of losing is psychologically twice as powerful as the pleasure of gaining.

That is, an otherwise ‘rational’ human would prefer not lose $10 than to win $20.

Loss aversion explains why many vendors find it so difficult to sell for a price that they feel is a “loss”.

It doesn’t even need to be a real loss, it can be a perceived loss.

If they had a bank valuation done at a higher price, or a previous offer from a buyer that fell through, or even an appraisal from another agent a few years back, they set an ‘anchor’ price in their mind, and anything less feels like a loss.

It’s not rational, but the feeling of loss, regret, frustration or injustice are real.

Loss aversion makes it easy to focus on the $200,000 less (loss) that you might theoretically achieve for your house today compared to the peak of 2021, but ignore the $300,000 less (win) that you might theoretically pay for your new, larger home.

For some owners who bought in the previous peaks of 2017 or 2021, they would rather stay in a house that no longer suits their needs than to sell at a loss, so they are willing to wait until prices increase another 10 or 20 percent before selling. (Who knows how long this might take?)

The problem is, the properties they are looking to buy next will have also increased by another 10 or 20 percent, so if upgrading they will be far worse off by waiting.

It makes more logical sense to take the loss now and get into a more suitable home that, if it is a larger asset, should appreciate relatively more in the long term.

Likewise, some investors are willing to hold an investment property with a negative yield and myriad potential headaches (bad tenants, broken plumbing) when they could be getting 4.5 percent interest from the bank, risk free.

Clearly humans are not rational though and emotions drive most of our decisions, especially the big ones.

If this weren’t the case, we’d be out of a job.

Disclaimer - This has been written for informational and entertainment purposes only. The views and opinions expressed are the author's own and not those of Jellis Craig.