One characteristic of human
nature is that we all hate to lose. In more scientific terms it is called loss
aversion. There are some differences in what and mainly HOW we lose. My focus
is on HOW we lose things, particularly if there is an active decision of the “loser”
to lose or admit a loss.
People can feel “loss pain” when
they lose something. The easiest example is when one loses 10 Euros just
because they felt out of the pocket. But, this is not so interesting, since it
is obvious that no one will be happy to have lost money, a phone or whatever.
Similarly people feel “loss pain” when something is stolen (oh… I remember how
I felt when my first bike was stolen) and to the “loss pain” a feeling of injustice
is added. We can feel that we lose something that we never had. People feel the
pain of los even when they lost something that they never had. For example
someone can feel “loss pain” when informed that they could have got something,
but didn’t get it. Here regret (if only I would have done something different) plays
a role. However, feelings of injustice or regret are not the topic of this
post.
In the situations mentioned
above, loss is independent of the person who suffers it. Of course the “loser”
could have done the appropriate thing to get that reward. Of course, the “loser”
could have been more careful with money and take some preventive measures to
avoid theft (like using 3 locks on the bike, which I now do). But more or less
the “loser” didn’t do anything to actually lose.
What I find very interesting is active
losing or in more plain language – Saying “Good Bye” to something.
Active losing implies that loss is
one step away. Let me give you an example to clarify. Let’s say
someone has a lot of shoes (yes, there is a sex difference in the number of
shoes someone has). Due to the high number of shoes, there is no more space in “shoe
storage area” and some shoes don’t have room in the “storage area”. Now,
to experience loss, she has to throw away (donate to charity) some pairs of
shoes. In this case our “loser” has to actively do something to actually
experience loss.
In the “shoe example” loss in not
inevitable, because she can keep all her 200+ pairs of shoes and if she does
so, she will not experience “loss pain”. In this case a person has to make an
effort (minimal) to actually lose. Prospect theory tells us that at least for
relatively small losses, the pain of a loss is roughly double in magnitude compared
to the pleasure of a similar gain. To translate this into shoes… in order to
compensate for the loss of one pair of shoes, she will need to have two new
pairs. This is the scientific explanation for the ever growing number of shoes,
clothes and many other things including (power) tools that are used at most twice
a year (yes guys… we don’t collect shoes, but look in your “tool box”).
Another case of loss that is “one
step” away is when the loss is inevitable, but one has to acknowledge the loss,
to actually make it tangible. Take the example of investments in assets. Imagine
someone that invested in a piece of real-estate (don’t you just love real
estate???) and buys at 2500 Euros/square meter.
In the next year the price goes down to 2200 Euros/square meter. This
person has lost a great deal of money… 300 euros * surface of the property.
However, the loss is not “real” unless the investor sells and acknowledges the
loss. By real I mean actually experiencing “loss pain”. The investor will think
that:
“Maybe the prices will go back up to 2500 Euros… or maybe even higher…
after all the prices were rising for a long time and what reason do they have
to not do so in the future??? I should wait some more for the prices to “come
to their senses”… moreover, I’ll go to church and say a special prayer”.
You get the idea of inevitable
losses that are not acknowledged, right? You might think that only naïve investors
do foolish things like this… don’t feel alone! Even professionals hold on to
assets decreasing in value in the hope of “prices coming to their senses”.
In both the “shoe” and “real
estate investment” examples we have a case of “it’s hard to say good bye”
because the person has to actively “say good bye” and acknowledge a loss. Because
people hate to lose, it is hard to say “good bye”. Before presenting the
reasons why “saying good bye” is in fact good and telling you how we can use
loss aversion and prospect theory in our favor, let me give you another example
of “hard to say good bye”. This example was brought to my attention by Dana Ududec.
Dana is an “environmental
friendly” person and she recycles stuff that other people would just put in the
garbage can. Dana told me a story about her washing a plastic box (previously
with some food inside) before putting it in the “plastic recycling” bin. (Yes
my Dutch friends, in less developed countries plastic is recycled). Her dilemma
was if the act of washing the plastic box was, in fact, more detrimental to the
environment than the act of recycling it. Now, I will leave that answer to the
environmental professionals who can make the cost-benefit analysis. My question
is “after washing the box did she actually throw it away (recycle)?” I’m not referring
to the particular case of my friend (after all, I can simply ask). Rather I’m
curious if one makes an effort with regard to an object that is basically
useless will that person get rid of the object?
If we make an effort (investment)
in something, does its value suddenly increase? What if someone else made the
effort? The answer is “yes”. If we made
an investment in something, regardless of how useless it is, we will hold on to
it. Let’s drop the plastic box into the recycling container and think about a
job… if someone had to put up with a “lot of sh*t” to get a job… he or she
would hold on to the job even if they get even more “sh*t”. In comparison,
someone that got a job without making a huge effort would be more likely to
leave the job when “sh*t” is served. The key idea here is that in the cases of
the plastic box and of the “sh*tty job” what is lost is not only the “thing”
(box or job), but mainly the effort put into that “thing”. The extra effort is
what makes it “hard to say good bye”.
What if someone else made the
effort? You can answer that question by simply looking around the house and
count the perfectly useless things that you have received as gifts from people
who are more or less close to you. If you counted more than one, then you
suffer also from “it’s hard to say good bye”. The idea is that by getting rid
of all those useless and sometimes kitsch objects you don’t only lose the “thing”
but also the nice gesture that your friend or mother in law made.
Now let’s go back to the “why
loss is good” part. Economists (that “special”, but somehow useful species of
people) have developed the concept of “opportunity cost”. It basically refers
to what else could you have done with that resource (money, time etc.).
For
example by holding on to an asset that loses value in the hope of “prices to
come to their senses”, the investor gives up all the other things that could be
done with the remaining money if the loss would have been acknowledged. In more
simple words… if the investor puts 250.000 euros in a 100 square meters real
estate property (at the price of 2500 euros/ square meter) and in the next year
the value of the property goes down to 220.000 euros our investor has two
options. First, (s)he can wait for the prices to “come to their senses” and not
acknowledge the loss. Second, (s)he can sell, acknowledge the 30.000 euros loss
and invest the remaining 220.000 euros in other assets such as Apple stocks
(although I’m not sure if that is a good investment) which have a better return
on investment. By going for the first option (holding on, hoping and praying)
the investor loses the benefits of the second option. This is the “opportunity
cost”.
So, sometimes it is not necessarily
bad to loose. Maybe in a loss there’s a hidden opportunity of a gain in another
area.
Leaving the investment world… and
going back to the “shoe storage” area… why is it good to lose some of the shoes
(or tools or whatever). First, it is very useful to give up on some shoes for
simple practical reasons. Imagine what you could do with all that space…
Second, by accepting to lose some of your stuff the relationship quality will
increase. Everyone that lives in a couple has experienced those annoying discussions
like the following ones:
She: “I’ve told you 10 times to
clean up the garage / basement / attic! It’s full of your tools and paint/
silicone/ stuff left overs!”
He: “But honey, those are MY
tools and I need all 2458 of them. Plus, the left over materials are perfectly
good; why throw them away? Who knows when I might need them?”
Or:
He: “Whenever I want to get
something out of the closet your damn shoes fall on my head! You should get rid
of them!”
She: “But honey, I don’t have “that
many” shoes! Gloria has more! And by the way I still have some outfits for
which I don’t have matching shoes. Saturday I’m going shopping with Gloria.”
This is not exactly the evening
chat that one wants to have… Now really what is more painful? Fights on a
regular basis with your “better half” or experiencing some “loss pain” once?
Rationally speaking one instance of “loss pain” is better than a regular discomfort
of marital disputes. However, being rational is quite hard… and for this
decision design can help a bit. Let me tell you how.
Here are some insights that can
be applied.
First, set a rule with your “better
half”, with a friend or even with yourself. For each new thing that you buy
(shoes, tools etc.) you should throw away (donate) one of your old things. As I
said earlier the pain of a loss is roughly double in size compared to the
pleasure of a similar gain. When faced with a loss one would be more reluctant
to buying new stuff. I’ve tried this with my wife and we managed to keep the
number of shoes constant in the house. Lately she offered to through away some
of her clothes so that she can buy new ones.
Second, set up regular clean-ups.
At least twice a year go through all your stuff and look for things that you
haven’t used in the last 1-2 years. Most of them are perfectly useless if you
haven’t used them. And if the phrase “Who knows when I might need it” let me
tell you a painful truth. If you don’t know when it might be useful, then it is
not useful. In the same line of thinking go through your clothes and whatever
you haven’t used in the last year, put it in a bag and give it away to charity.
Never mind those cool trousers that you had in your college years. They are not
cool anymore and most likely they don’t fit you anymore. And NO! Don’t hope
that you’ll get back to your “good days” silhouette.
Third, go through all the gifts
that you have received and you’ve never liked or used. Put them in a big bag
and just get them out of the house. Yes… corporate gifts included (those are in
fact the most useless ones). Do this all at once since the “per unit loss pain”
decreases with the number of units. In other words if you throw away one object
each week the cumulated “loss pain” will be higher than the “loss pain” of
throwing them away all at once. If you still feel bad about losing the
investment your friend made, know this: Your relationship and good feelings
about your friend don’t reside in an uninspired gift. Even better: after
throwing the useless gifts away, call your friends and organize a “get together”.
That is what friends and relationships are about. OK… there is one exception to
this rule. If your mother in law is very easy irritated by your (imagined) disrespect,
don’t throw away the kitsch vase she gave you as a wedding present.
Fourth, Give your junk to charity.
I have to tell you that not all you give to charity is actually used by less
fortunate people. For some things the charity is only “one more stop” on the
way to the landfill. At the same time, a lot of things find a “new life” in
second hand stores (the very table and chair I am using to write this are
second hand). Even better, some of your old useless stuff will make happy many
less fortunate people in your country or abroad. The benefit (good feeling) of “doing
something good” or being altruistic will help attenuate the “loss pain”.
Fifth, enjoy your new comfort in
your own house. Less stuff, more space; more space, more comfort and new
opportunities.
It is hard to say “Good Bye” but
in many cases it is very Useful and Relieving…
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