☀️ SOL Edition #4, 2024 ☀️
At the age of 29 and 33, two young American men began a trek that would define history and come to be known as the Corps of Discovery. Prior to their journey in 1804, many societal doubts and uncertainties existed which nearly prevented the political sponsorship making their expedition possible. Common opinion doubted whether a practical water route existed across the newly acquired Louisiana Territory. The travelers were expected to be greeted by hostile encounters with unknown indigenous tribes across a vast expanse of uncharted wilderness. The harsh and difficult terrain alone would threaten the security of food, water, and lives of members on the journey. Educated officials and elites pushed back on whether President Thomas Jefferson’s vision of westward expansion was worth the investment of resources and manpower given the uncertainties and risks involved. Nonetheless, the successful expedition of Lewis and Clark spanned over an estimated 8,000 miles charting the uncharted American West, reaching the Pacific Coast (near present day Astoria, Oregon), and left a lasting legacy in the history of exploration, discovery, and scientific research.
For most, uncertainty is something we try to avoid completely or at the very minimum reduce. But we owe a lot to uncertainty. Thanks to uncertainty, we are able to enjoy the conclusion of a sporting event like March Madness, achieve outsized returns in the market, or enjoy a sunny day when it meets us in the present moment.
When we think of uncertainty, we’re almost immediately drawn to the negative consequences of the term, rather than the positive. Why is that? It’s due to the concept of Loss Aversion.
Loss aversion is a cognitive bias that refers to the tendency of individuals to strongly prefer avoiding losses over acquiring gains of equal or even greater value. In other words, people tend to weigh potential losses more heavily than potential gains of the same magnitude. This bias can influence decision-making in various areas of life, including finance, economics, and psychology.
Loss aversion has become a key concept in behavioral economics, and it plays a significant role in understanding how we all make decisions. It can lead to worse decision-making primarily because it skews individuals’ perceptions of risk and reward, causing them to prioritize avoiding losses over maximizing gains. Several key factors contribute to this phenomenon.
Narrowed Focus — In what we believe is making our lives easier (and often does), our mind prefers to reduce the number of responses we have and proceed forward. Sometimes, this narrow focus can prevent individuals from fully considering all available options and making decisions that align with their objectives.
Emotional Impact — Loss aversion is driven by emotional responses to potential losses, such as fear, anxiety, or regret. These emotional reactions can cloud judgment and impair individuals’ ability to make rational, objective decisions. Instead of weighing options based on their inherent value or likelihood of success, individuals may react impulsively to avoid experiencing negative emotions associated with loss.
Anchoring Bias / Sunk Cost Fallacy — Individuals may anchor their decision-making to the status quo or previous investments, even if those decisions are no longer optimal in the current context. Or they continue to invest resources (such as time, money, or effort) into a knowingly sub-optimal course of action simply because they have already committed resources to it.
To neutralize loss aversion,
- Widen your horizon of the decision and consider “out of the ordinary” alternatives (push back against the narrow focus and walls you may have unintentionally created in your mind).
- Assess the situation as if from a third party point of view. Back out of the decision and treat it from the perspective of one of your friends or simply a rational and uninvested observer.
- Eliminate past history by approaching the decision from today onwards. Look forwards only, making an effort to recognize and remove past anchors and previous investments which may be clouding your judgment.
David Booth, Founder of Dimensional Fund Advisors, a privately held investment firm which manages $677 billion (as of December, 2023*), puts it this way in his article “Uncertainty is Underrated” which inspired this post.
“We can’t control the weather, but we can take an umbrella if it looks like it might rain. We weigh the cost of carrying around an umbrella against the benefit of staying dry if it rains. We manage risk with our health, work, family, and just about every other part of our life — including investing — because, while few things are certain, we still have to make decisions big and small. The better we manage risk, the better our lives will be… With uncertainty you make the best-informed choices you can, monitor the results, and make changes as necessary…The key is to develop a philosophy, define your goals, and steer toward them, adjusting along the way. You might not only be underestimating uncertainty, but you may be underestimating the positive impact of embracing it.”
— David Booth
What is the ☀️SOL Series☀️?
SOL simply stands for a Subject Of Learning. I am pushing myself to process thoughts into more concrete understandings of the world providing material conclusions while simultaneously improving my writing.
The collective profile (and virtual community) will become a Strategic Atlas for individuals to gain perspective on global trends, philosophy, and cognitive science. The aim is nothing other than to become rich in perspective leading to strategic mental growth.
— Atlas
