How to Control Your Fear of Losing Money
By: Mathieu Gouraud
Tags: Behavioral Economics, Behavior Change, Financial Planning, Money Mindset

We’ve all heard sensational stories about people that took risks which propelled them to success.

We may just think that they got lucky and that if we were in their position, the risks just wouldn’t be worth it.

But the truth is that we often over emphasize risks and in many instances it is the very thing that is keeping us from making more money and achieving a successful life.

The concept behind why most people don’t take risks is called loss aversion.

Over the next several paragraphs, I explain what loss aversion is and where it comes from, how it affects our financial decisions and what we can do to fix it.

Why we Fear Losing Money: Loss Aversion

Loss aversion is defined as the tendency to prefer avoiding losses to acquiring equivalent gains. This happens because our emotional response to losses is stronger than the response to corresponding gains.

The concept of loss aversion was discovered in 1979 by two psychologists: Daniel Kahneman and Amos Tversky.

The following example might illustrate the concept a little better.

Imagine you are asked to gamble on the following scenario:

You toss of coin and if it falls on:

Head: You win $150

Tail: You lose $100 dollars

Would you take the gamble?

Most people say no even though the rational choice would be to take the gamble. the expected reward is positive ( 50% x 150–50% x 100 = 25).

The reasoning is that the psychological discomfort that you feel of losing 100 is more intense than the psychological comfort of winning 150.

You can actually measure your loss aversion by asking yourself what is the smallest gain that you require for your loss to be worth it.

If you required a win of $200 for the above example, your loss aversion ratio would be 2 (200 / 100).

Usually, the higher the stake (the more you have to lose) the higher your loss aversion ratio is.

The below graph is a nice way of representing your loss aversion.

Why Some People Fear Losing Money more than Others

While there is still much to be learned about this bias, below are a couple theories about why some people fear losing money more than others.

Environment

A lot of our behaviors can be partly explained by the environment we live in, including our fear of losing money.

People who are in an environment characterized by good social connections and support take more risks because they have others to fall back on.

I know that if I ever mess up, I will still have my family and my friends supporting me and helping me get back up.

That is not to say that this is a reason to make reckless moves, but I probably take more risks than a person who does not feel as supported.

Experiences

People that lost money because they either invested too much into one stock or sold their investments during a market crash probably associate the stock market with losing money.

Even though a well thought out investment strategy and proper diversification has a lot more chances of making you money in the long term, past experience can trump any logic and exacerbate the effects of loss aversion.

Socio-Economic Status

Some people are just in a position where they can afford to take more risk.

100 dollars is not worth nearly as much to a millionaire than it is to a person with a few thousand bucks to his name. The amount at risk of losing would have to be a lot higher to dissuade a millionaire

People with strong in demand job skills can also take more risk in terms of their careers. For example, there is a higher demand for coders than there are coders, so they have more leverage when it comes to finding and negotiating jobs.

Neurology

Finally, purely biological reasons can also explain why some people have different levels of loss aversion.

Just like athletes for certain sports are born with natural abilities, some people are born with a brain makeup that make them more or less prone to loss version.

However, just like athletes, practice is necessary to develop any skills.

In this case, practicing certain activities, like meditation, can change some of our brain’s structure and make us less vulnerable to loss aversion.

How Loss Aversion Affects Your Finances

Loss aversion affects every area of personal finance, from saving to spending and investing.

Saving

Saving money usually entails making a sacrifice in terms of what you could have spent it on.

Let’s say your friends ask if you want to join them after work to go for a drink. You know you will end up spending quite a bit of money if you accept. But you also think that you will miss out on the fun if you don’t join them.

We often refer to this as Fear of Missing Out, or FOMO, a more commonly used term to describe loss aversion.

I am sure we’ve all experienced this. Often times, nothing amazing happens. It is unlikely that you are going to meet the love of your life that night going out with your friends.

It is more likely that you’ll wake up with a hangover and regret spending so much money on an average night.

Spending

The same goes for spending.

We live in a world where we can get so many things for free nowadays. So we are conditioned to avoid spending money, even if the price of the service or product that we seek is worth it.

I’m guilty of this myself as well.

Instead of spending a bit of money on a service or product that could add a lot of value to my life, my loss aversion prevents me from seeing its actual value.

Or I will waste hours trying to find something for free, like a free pdf of a book, only to conclude that there is nothing and end up buying the book on Amazon.

Investing

The fear of losing money may well be the number one reason why people refuse to invest.

Back in August of 2018 I was in this position. I had started my job about 8 months before so I had some savings in my bank account but I did not want to invest.

My reasoning was that I thought a market crash was coming since there had not been one in over ten years.

Looking back at it, this was a terrible reason not to invest. My fear of losing money clouded my better judgment.

I eventually invested a few weeks later after taking some steps to overcome my fear of investing…

How to Control Your Fear of Losing Money

Research

Research is key to overcome this bias. Whether you are investing or deciding whether you should spend money on a product or service… research, research, research!

As I’ve mentioned, our perception of risk is often misaligned with the actual risk that we are facing. By doing your research, you’ll get a more accurate picture of the real risks.

In my case, when I started investing, I realized there was no way of telling whether a market crash would be coming.

Also, all the evidence pointed out that the earlier you invest, the more likely you are to make money if you are investing for the long term.

Change your Perspective

Frame the problem or situation another way!

Instead of asking yourself how much money can I lose if I invest, ask yourself how much money can I lose if I don’t invest?

Let’s say you have $50,000 and you decide to keep them in a savings account for 30 years instead of investing them. How much are you “losing” by not investing?

Taking into account the fact that your money is worth 2% less every year because of inflation and an inflation-adjusted average return of 6% for your investments, these are the results:

Your $50,000 after 30 years in a no interest savings account would only be worth $27,831.

On top of that if you had invested your $50,000, it would be worth just over $270,000.

That’s a difference of…

wait for it…

$243,000!!!

Put another way, you just lost $243,000 by not investing.

Plan in Advance

One of the best ways to reduce your fear of losing money and avoid being poor is by putting yourself in a situation where you can take more risks. And that comes with planning.

The number ONE thing to have is an emergency fund.

In the summer of 2020, I got laid off and my emergency fund allowed me to take more risk and spend time on setting up this blog before finding work again.

If I had not planned in advance, I would have been forced to find another job right away and would not have had the time to assess other better options.

When Fear is Healthy

It may sound like I am demonizing our fear of leaving money and that we must suppress it at all costs if we don’t want to be poor.

But I want to leave you on a more positive note.

There are some instances where the fear of losing money is good, and is what keeps us from being poor.

Making Better Investment Decisions

Fear can make you search for the truth and push harder to find evidence before taking any action.

Starting to invest can seem very daunting and we are often drawn directly to single stocks when we start out.

You know that investing is good, but you are scared about putting most of your hard-earned money into one stock.

Your fear prompts you to learn more about investing. The more you read about it, the more you realize even most professional investors can’t beat the market.

You also learn that index investing a much safer investment strategy than investing into a single stock or even choosing a basket of stocks yourself.

After reading this, your initial fear is eased and you opt to invest your money with a robo-advisor using an index fund approach.

Commitment Devices

There is one technique where you can use your fear of losing money to your own advantage. This technique is known as a commitment device.

It’s a great way to get you to pick up good habits.

The way it goes is you make a pact with your friends or yourself and if you don’t follow through you have to pay up.

For example, if you don’t go to the gym at least 3 times a week then you need to give your friend $10 . The psychological discomfort of losing $10 dollars gets you to follow through and in a matter of weeks you don’t even need this commitment device to go to the gym anymore.

Conclusion

Our fear of losing money is very often overestimated. There are external factors which are not in our control that can make us a lot more vulnerable to loss aversion, and that is completely okay.

What you need to focus on is the controllable.

By focusing on the aforementioned techniques I have described, you can have a much better gauge of the reality of the risk compared to your perceived risk.

Also, don’t forget that fear can actually be healthy, just don’t let it get to an extreme level.

As Frosty says in the movie Maverick’s… “Fear’s healthy, panic’s deadly”.