Bruce Wayne and the Avoidance of Pain
How many times have you come across an attractive stranger, but been afraid to initiate a conversation? Maybe always imagined yourself as a YouTube Influencer but gave yourself no chance of even trying to make one single video? Or perhaps been stuck with a toxic friend you never found the right time to ‘cancel’? Or that book that’s in your head but you never found time to even start it- in the last 15 years? 🤦
Humans are naturally hardwired to avoid risk. And I know it’s true because Batman said it first.
In an enigmatic scene from The Dark Knight Rises, we see Bane escape from a pit-prison.
The story goes on to say that in order to escape the hellish prison pit, one would have to let go of the safety rope, do a free jump upwards, get a foothold on the upper rim of the pit and then climb out. Impossible!
The escape story of The Pit is mythical, maybe next to impossible. The free jump could very easily turn into a free fall and a certain death. The other prisoners inside are so afraid to die that they do not risk the free jump - and thereby forgo their only shot at a free life. In other words, their aversion towards loss of life, even a life that’s literally the pits (see what I did there?) holds them back from the chance at freedom.
Let's take a moment to wonder what we are actually afraid of when we convince ourselves to stay in our comfort zones, rather than risk something for a shot at a better future. Often, it’s just the loss of stability we fear, the loss of social options, of comfort, and ultimately, (if we failed) the loss of pride.
We are programmed, it would seem, to turn away from the risk of something new to avoid losing the familiar. It is almost a reflex.
It is not surprising, therefore, that this aversion can play tricky games with your investment decisions too. Are you making decisions that hold you back from potential gains simply because you are worried about incurring a loss? You may not realize it, but you’re enacting the Loss Aversion Bias.
Avoidance of pain: The loss aversion bias
Loss Aversion Bias is one of the most common biases prevalent among investors and comes from the delightful world of behavioral science.
Behavioral finance is one aspect of this science, and as you might already know, acknowledges investors' behavior as being not always rational. It uses psychology to understand investment decisions, identify the biases that stand between investors and better earnings, thereby giving investors a launching board for more productive (and possibly, rational) investment strategies.
Loss aversion is the very distinct human reaction to potential loss versus our response to potential gain. It is based on the premise that people avoid doing anything that could cause them potential loss.
And this drive to avoid loss is often a stronger driver than the potential gains available.
Pain = 2X more powerful than Joy
Studies support that we are likely to find losing a sum of money (say Rs 1,000) twice as painful as the joy we would experience upon accidentally finding the exact same amount!
Avoiding loss seems to spur us on more than twice as much as gaining a similar-sized profit. If you knew this already, do leave a comment behind.
Now let us show you 5 ways how loss aversion bias manifests in investing behavior and what fears lie at its roots:
1. An investor might hold on to a loss-making investment because they are afraid of selling it and incurring actual loss (even if small). They hope things will turn around, are afraid of taking a hit that could be avoided, even though rational analysis tells them otherwise. Some people might call it ‘optimism bias’, but you get the idea.
2. Similarly, an investor might sell a stock that is on the rise and has a long-predicted upward trend ahead of it, simply because he is averse to the risk of the stock price declining later on at some point in time. If you think like this, you may book any profit you become aware of, instead of letting your profit get exposed to further risk, in-turn losing out on further gains!
3. An investor might also invest in a particular mutual fund simply because of a fear of the loss of a potential opportunity. This is linked to FOMO (fear of missing out) and herd mentality, and is often a reason why people invest during IPOs, a delicious topic we wrote about a few weeks ago.
4. Choosing low-risk investments that seem to offer a certain guaranteed return, not because their risk profile doesn’t allow risky investments, but because ‘guaranteed hai’. But aren’t you forgetting- Risks ke aage (shayad) aur bhi returns hai? Did we just play a FOMO game on you by writing that though?
5. Avoiding investments that offer potentially high returns because they carry a high degree of risk. Similar but different to the previous point.
Note: Read the italicized note at the end of this blog if you went “Wait a minute!” while reading the points above.
If you look at the past habits of Indian investors, you will notice a clear loss aversion bias wherein people locked up their money in their own home-safes or fixed deposits, or perhaps in real estate (guaranteed growth perception?) or gold. These were traditionally seen as safe and guaranteed investments options. Or pushed by Mummay-Papa.
The bottom line is this: people are so fundamentally fearful of the ‘perceived pain of loss’ that they put all their focus into avoiding that loss, giving much lesser attention towards making profits.
Now I must add, it is by no means wrong to be afraid of loss. Fear is what keeps us safe. In fact, legendary investor Charlie Munger often talked about an interesting idea of “inversion” based on a similar thought process you will benefit from, by saving the image below.
So keeping the fear of loss in your mind is not a problem by itself- it is in fact good to be aware of potential risks. It is an excessive focus on this potential pain of loss which can cause you to think irrationally and can become counterproductive for your investment portfolio too.
Loss Aversion Error: Brain not Found?
So what exactly is happening in our brain, at the time when we display loss aversion bias? Psychologists have found that three areas of our brain ‘light up’ at the point where we go off the handle to try and avert a loss. These are the parts that process:
So here's what happens in your brain:
Fear Country (called the Amygdala, if you must know) in your brain gets activated, and you're driven by the same impulses that kick in when you encounter other situations that scare you, like how you might feel at the edge of a cliff or when you're drowning.
Loss Country (called the Striatum) also gets activated. This area has again been found to light up more for loss than for gain, perhaps a function of survival instinct? All prediction errors you might have made throughout your life are part of the programming here. Lots of past errors and resultant losses mean ‘redder, louder’ warning signals.
And to top everything, Disgust Country (the Insula) works in tandem with Fear Country to avoid certain types of behavior, the kind that result in disgust… like being labeled a loser, perhaps? Someone who… Lost? Made losses? Didn’t do well? Fell behind? (This sounds a lot like me now)
In other words, potential loss puts us in a crisis mode. We don’t think rationally because our brains just focus on avoiding loss.
So how do we fight this bias and reach for the stars? Well, I am delighted to present 5 potential remedies below.
Loss aversion #BreakTheBias 101
1. Make yourself consciously recognize if you are in any of the 5 loss-aversion bias situations we wrote about, above. Stop yourself from falling in the same trap the next time and use numbers to make a rational decision.
2. Make a second, uncorrelated investment (to diversify from the first one that may be making you feel rattled. That way, you can offset potential losses- what’s called hedging.
3. This one must be underscored: Pay for value. As far as rules for investments go, this is the star of the show. Buy when the price is right - this takes dedication, research and time. Or an expert financial consultant who can do it on your behalf (like a MF Distributor). But this is a key, tangible move towards avoiding risk. It also might mean fighting herd mentality.
But is there any real safety in numbers? Not really, as I wrote earlier in Will you jump off a cliff, too?
4. Contrary to what motivational speakers often say about Life, never go with your gut when it comes to investing. Never, ever. All your investment decisions must be rooted very firmly in rational analysis. A company’s balance sheet and cash flows are far more reliable indicators of its potential to generate wealth for you than ‘My Pappa, or my Heart (often the same) said so!’
5. Employ reasonable measures to reduce risk. This is especially true for those who like high-risk plays but then cry when things go down. Choose government bonds, buy a fixed income mutual fund or two, add some FDs if you really want to ‘feel’ the guarantee. Basically, diversify your portfolio with stuff that can help absorb the impact of market fluctuations.
The Bottom Line
Unless some clear facts or numbers or a well-guided strategy is driving your investment decision, you are probably being driven by Loss Aversion Bias (or Herding, or Confirmation, or Recency, among many others).
Like with any other bias, all you need to start with is a promise to yourself, to be more rational the next time you make a decision. In life, as in investing.
Now, to bring things a full circle, let’s go back to the prison pit scene we started with. After besting him in combat and nearly breaking his back, Bane has Bruce Wayne (Batman’s alter ego) dumped into that prison, with the intention of making him powerless to do anything meaningful ever again. What happens next? Over time, Bruce manages to heal himself (he’s our hero, after all), and recovers enough of his strength to attempt the impossible leap that’ll get him out of that hellhole.
What was at stake for him? Failing and falling would have possibly crippled him, if not outright killed him. Yet, he goes ahead, makes it across the chasm and manages to get out of the prison (eventually saving millions from a nuclear holocaust!).
It’s not that Bruce ji wasn’t afraid. But instead of being paralyzed by his fear, he was able to tame it, and perhaps even channel it in a useful way.
And that’s one key lesson that investors should take away. Use the fear of loss to propel yourself to better decisions and tame the monster so that it doesn’t get in the way or being rational. Remember: Such a potent relationship with fear is exactly what turns ordinary men and women into heroes… or ‘real’ investors. 😎
FYI- In the section Pain = 2X more powerful than Joy above, you might have noticed I’ve also revealed one part of the psychological playbook of many investment-marketing teams- “How to harness the fear of investors for self-gain?” Does this include us as well? You know the answer. But we at DSP don’t mind you knowing about this- honest asset management requires us to be transparent, after all. More importantly, the more you’re aware, the more likely you are to be able to see through mere gimmicks. Watch out for fear-mongering, and give some extra credit to those who, among their shiny marketing efforts, also take the time to showcase what could go wrong if you invested in something (not just what you may miss out on if you didn’t invest!). Most importantly, like we say, stay rational and #BreakTheBias.
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