The Utility of Loss

I learn something new about every 10 minutes these days. But when we covered Prospect Theory last week, I had a real Epiphany.

The chapter discussed irrational decision making (I’m kind of an expert), and examined the underlying reasoning, which turns out to be shockingly simple.

It seems that people don’t like to lose. Anything.

This is why we eat the whole cake (because wasting is losing) or why we don’t throw away old, broken things (like dot matrix printers). Or we sell our good performing stocks but hang on to the bad ones.

We. Don’t. Like. Losing. In fact, we hate losing MORE than we like winning.

Prospect Theory & the utility of gains/losses

Prospect Theory & Utility Function. You’ll notice that the slope of the Loss Line is steeper than the slope of the gains line, suggesting that the rate of change is generally higher for losses. In plain English: losses hurt more than gains feel good.

Rational decision makers look at decisions based on how they affect their total wealth/well-being and “cut their losses.”

They don’t wait for the stock to “come back up” or hold out hope that a bad relationship is going to improve. All the money, all the time invested are “sunk costs ” and shouldn’t be used to evaluate what you do going forward.

Don't water the dead plants.

Don’t water the dead plants.

The tricky part is recognizing which plants are dormant and which ones are dead.

About Laura Alford, PhD

I'm a recent graduate of LSU (PhD in Accounting). In addition to academic research, I also write fiction on Tuesday nights with the Asilomar Writers.
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