I read an interesting theory the other day in an investment guide by Jason Kelly. He sites a 1979 study by Daniel Kahneman and Amos Tversky that looked at the following scenario…
Subjects were told to choose between these two prospects…
Prospect 1: A 100 percent chance of losing $3000
Prospect 2: An 80 percent chance of losing $4000, but a 20 percent chance of losing nothing.
Which would you choose? In the study, 92 percent of the prospects chose prospect 2. The chance of losing nothing, even though it was improbable, was compelling enough to risk losing even more. Prospect one, however, is likely to lose less.
This is an interesting finding and one that contrasts with…
Subjects were then told to choose between these two options:
Prospect 1: A 100 percent chance of gaining $3000
Prospect 2: An 80 percent chance of gaining $4000, but a 20 percent chance of gaining nothing.
Which would you choose? In the study, 80 percent of the subjects chose prospect 1. The guarantee of gaining something was more appealing than the prospect of gaining more. Prospect 2, however, is likely to gain more.
In conclusion the study found that people hate risk when it threatens gains, but they love risk when it could prevent losses. In fact Kahneman & Tversky found that… “loss is painful, on average twice as painful as gain is pleasurable in matters financial.”
This study has wide implications to the whole idea of risk and personal development.
- It helps explain why people stay in dead end jobs instead of taking a risk to find a better one.
- It helps explain why it is hard to get people to speak in in front of an audience and improve their public speaking, when the risk of embarrassment is so high
- It helps to explain why people try to win back their losses in gambling.
This also has some interesting implications for dieting. From the findings it would seem that it would be better to focus on the health benefits of a diet (averting health problems and possible loss of life) versus the gain of a smaller waistline.
One of the conclusions I have come to in this scenario is to ask the negative question that we looked at in our post on risk…
1. What is the worst thing that can happen if I don’t take this risk
2. What is the best thing that can happen if I don’t take this risk
This may help us see that the actual risk might be higher if we don’t do something than if we do.
Something to think about…