Loss aversion is the name for the human tendency to care more about losses than wins. In other words, the pain of losing outweighs the pleasure of winning. This can have a big impact on your financial goals. Here are three ways loss aversion can cost you money:
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1. You Throw Good Money After Bad
The classic example of loss aversion comes from a casino. People who lose money on a bet are unlikely to give up, collect their things and head home. Instead, the pain and regret of the lost money will cause them to bet more in hopes of coming out on top. Do we need to tell you this doesn’t work?
Even if you never gamble, you could still be a victim of your own loss aversion. For example, making a purchase that isn’t quite right and then spending additional money trying to recover from your mistake. Maybe you bought an expensive item of clothing that doesn’t really work for you, so you spend more on accessories to jazz it up rather than returning or donating the item. That’s throwing good money after bad.
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2. You Hold on Too Long
Because we tend to fear loss more than we desire gain, we hold on too long. We consider the “sunk costs” of money and time rather than moving on. We may hold on to questionable investments, stay in bidding wars on eBay, keep items that aren’t adding value to our lives, or rack up student loans in programs that aren’t a good fit.
Imagine what your life would be like if you weren’t loss averse. You could make money by selling things you no longer need or want. You could reap bigger investment gains by accepting the possibility of loss. You could upgrade from a job that isn’t going anywhere, a car that eats up maintenance costs or a fixer-upper that isn’t coming together.
3. You Buy Too Much
Do you walk around a store adding things to your basket, planning on paring back before you get in line to pay? Do you add items to your cart online “just in case”? If so, loss aversion could mean you spend more than you planned. It’s hard to put items back, whether online or in real life, so it’s easy to end up buying more than we intended. To avoid overspending, only pick up things that are within your budget and were on your list of needs before you hit that store or website.
The Takeaway
Your time and money are precious commodities – don’t let loss aversion use them up! The money you free up when you break free of loss aversion could go to your 401(k), or a down payment on a home. Worth it.
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