Losing Rp1 Million Hurts More Than Gaining Rp1 Million Feels Good. That Is Loss Aversion
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5 min read
Someone offers you a coin flip. Heads, you win Rp2 juta. Tails, you lose Rp1 juta.
On average you come out ahead by Rp500.000 per flip. Yet many people say no.
That reaction has a name: loss aversion. It is the tendency to feel a loss more strongly than a gain of the same size. This post explains where the idea comes from, what the research says (including a fair challenge to it), and one way to check whether it is steering your investing.
Loss aversion means that losing Rp1 juta feels worse than winning Rp1 juta feels good.
It comes from prospect theory, a model of how people really choose when money is at risk. Daniel Kahneman and Amos Tversky built it. The 1992 version, "Advances in Prospect Theory", was published in the Journal of Risk and Uncertainty.
In that paper the pain of a loss was about 2.25 times the pleasure of an equal gain. This number is called lambda. Using it, the coin flip above looks different. A Rp1 juta loss "feels like" Rp2,25 juta. The Rp2 juta win does not cover it, so the bet feels bad even though the math is good. (Parameters of the 1992 paper, via a calculator page and a summary; I did not open the paper itself.)
Not everyone agrees on how strong it is.
In 2018, David Gal and Derek Rucker published "The Loss of Loss Aversion" in the Journal of Consumer Psychology. They reviewed the evidence and argued that it does not show losses generally weigh more than gains. They suggest the effect depends on the situation. (Paper listing on SSRN; I read only the abstract and summaries.)
Others replied that the effect holds in many settings, and that the "twice as much" number is what is overstated.
So here is a safe reading. Losses often feel worse than gains in choices about risk. How much worse changes from person to person and from case to case.
Loss aversion does not stay in the lab. It can nudge real decisions.
That last one has a name too: myopic loss aversion. "Myopic" means short-sighted. Shlomo Benartzi and Richard Thaler argued in 1995 that if investors check their portfolios about once a year and dislike losses, that can help explain why stocks pay a higher return than safe assets. (NBER working paper) Later studies found the result depends on the country and the period, so it is an idea to hold loosely. (Summary of replication work)
This is NetWort arithmetic with made-up numbers.
Take the coin flip again. Win Rp2 juta on heads, lose Rp1 juta on tails.
| Outcome | Chance | Money |
|---|---|---|
| Heads | 50% | +Rp2.000.000 |
| Tails | 50% | -Rp1.000.000 |
| Average result | +Rp500.000 |
Now apply a loss weight of 2,25. The tails outcome "feels like" -Rp2.250.000.
The felt average becomes (0,5 × 2.000.000) + (0,5 × -2.250.000) = -Rp125.000. The bet goes from a good deal to a bad-feeling one, with no change in the money.
The same thing can happen with a stock that is down. A rise of 25% might feel "not worth the risk" while a fall of 25% feels unbearable, even when the odds look fair.
Open the NetWort Dashboard and look at your Portfolio Health score and your positions that are down the most. For each one, ask: "If I had cash instead, would I buy this today?" Your answer shows whether you are holding for a reason or to avoid a loss feeling real.