The first step is to name the thought process. If a client can say, “I know that it is loss aversion that is influencing my decision-making process,” then they are, in effect, shining a light on the thought process. Just like anything else that people find fearful, when a bright light is shined on it, the amygdala tends to calm down and the fear subsides. Your client will find it easier to engage rational thinking once the fear is reduced.
By naming the thought process, we can also start to evaluate it. This works well under most circumstances. It has shortcomings, but at least when we name a process we can understand why it might fail and learn work-arounds.
When naming fails, we can try to manage loss aversion by “reframing.” The way a problem is presented to us—the way it is framed—will influence the solution we come up with for the problem. Tversky and Kahneman presented the following problem:
“Imagine that the U.S. is preparing for the outbreak of an unusual Asian disease, which is expected to kill 600 people. Two alternative programs to combat the disease have been proposed.”
The first group of participants was presented with the following disease program choices:
• Program A: Two hundred people will be saved.
• Program B: There is a one-third probability that 600 people will be saved, and a two-thirds probability that no people will be saved.
Seventy-two percent of the participants preferred program A and 28% preferred program B.
The second group of participants was presented with the following choices:
• Program C: Four hundred people will die.
• Program D: There is a one-third probability that nobody will die, and a two-thirds probability that 600 people will die.
Seventy-eight percent preferred program D and 22% preferred program C.
Note that programs A and C are identical, except that A is stated in terms of a gain and C is stated in terms of a loss. Programs B and D are also identical. What we see is that when a problem is presented in terms of a gain, people tend to prefer a more certain outcome, but if the problem is presented in terms of a loss, people tend to take more risk.
This suggests that one technique to overcome loss aversion is to reframe the problem from a negative frame of loss to a positive frame of gain. The attorney who did not want to move assets from her portfolio to pay down mortgages saw the reduction in her portfolio as a loss of freedom from working. She framed things using the size of her portfolio. If we had been able to reframe it in terms of her disposable cash flow, showing her that it would improve to the point where her needs were met and she would only be dependent on her investment portfolio in an emergency, she may have been able to “get over herself.”
Those clients who want to hold depreciated stock until it gets back to its original purchase price use as their frame the loss of principal if they sold. If the problem is reframed as a gain of cash that could be used to purchase a more productive and diversified investment, they may be able to sell and move on. For example, you could say to the client, “I know you paid $60,000 for that stock and if you sold it today you would only get $50,000. The goal is to get back to $60,000 as quickly as possible. If you had $50,000 in cash today that you wanted to invest to grow to $60,000 as quickly as is reasonable, would you put it in the stock you currently own?”
We now know how reframing affects the brain. Effective reframing leads to reduced amygdala activity and increases baseline activity in the dorsolateral and ventromedial areas of the prefrontal cortex and the striatum. These areas play very different roles.
First, reframing can make it easier for us to engage our prefrontal cortex—the part of our brain that most recently evolved. It gives us our ability for rational thinking, focus and control over emotions. It has limited capacity, it’s energy hungry and it can be disabled by strong emotions. With this in mind, reframing efforts are best attempted by people in well-rested, stress-free states. Easier said than done, but worth keeping in mind.