Loss aversion & decision making

From Sway. The Irresistible Pull of Irrational Behavior by Ori Brafman and Rom Brafman:

…it’s important to see how our aversion to loss plays out in our own decision making.

Think about the seemingly straightforward decision we make when we sign up for a new phone service. After wading through the phone company’s electronic menus, we’re presented with a choice: we can either pay for service by the minute or opt for a flat monthly fee and talk till the cows come home. Chances are that the pay-as-you-go plan is our better bet. Most of us just don’t talk enough to justify a flat-rate plan.

But at this point loss aversion kicks in; we start imagining ourselves gabbing like teenagers into the night. The fear of a monstrous bill looms, and we sign up for the unlimited plan “just in case.”

Fear of loss can motivate us to make decisions that end up being not in our best interest, such as in the example above or when buying an extended warranty that we never use.

Of course, fear of loss can motivate us to make decisions that DO end up being in our best interest, such as insuring our houses, cars, lives, and our ability to earn a living.

The trick is to analyze the situation objectively instead of basing our decisions on fear. It just takes a little time to figure things out:

How often do we really talk on the phone in a month? How likely is it that the object we’re buying will break the day the existing warranty expires? Can we get an extended warranty for free by using a credit card to make the purchase instead? What are the financial risks involved with not being properly insured?

A little fear can be healthy, but basing things on fear alone is rarely a good idea.