“Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas.”
– Paul Samuelson
A study in the Journal of Economic Psychology proposed that because people tend to associate gambling with losing money and investing with gaining money, they are less loss averse when the same financial decision is framed as an investment instead of a gamble.
The study was conducted by Xuesong Shang, Hebing Duan, and Jingyi Lu at the East China Normal University.
People hate to lose. People even tend to hate losing more than they enjoy winning. Nobel laureate Daniel Kahneman and his associate Amos Tversky called this phenomenon loss aversion – the general tendency for negative outcomes to outweigh positive outcomes. As Shang and colleagues note in the current study, loss aversion predicts that the sadness of a person losing $100 would be greater than the happiness that same person would experience if they gained $100.
Psychology researchers have long known about the framing effect -- the way things are framed can influence the way people perceive and react to them. For instance, people show a preference for pieces of beef described as being “75% lean” as opposed to “25% fat”, even though both percentages equate to the same thing.
Frames play an important role in financial decisions as well. The term investing refers to what is thought to be a positive-sum game where, in aggregate over extended periods of time, people stand to gain more than they lose. Gambling, however, refers to any chance-based activities in which the expected returns always favor the house.
Previous research has found that framing a decision as ‘an investment’ versus ‘a gamble’ influences how risky the people making those decisions are willing to be.
Building on these findings, across 6 studies, Shang, Duan, and Lu sought to determine how framing financial decisions as investments versus gambles affects peoples’ loss aversion for both hypothetical and real financial decisions. They hypothesized that greater loss aversion would occur if decisions were framed as gambles than as investments.
The purpose of Study 1 was to establish an understanding of the lay theories people hold about gambling and investing. To do so, they recruited 155 adults and split them into 2 groups, one to consider gambling and the other to consider investing. Regarding their given activity, participants were asked to report the likelihood of gaining money, losing money, and how much this likelihood was driven by chance. The findings suggested that people perceive gambling as more likely to lead to losses and less likely to lead to gains than investing. However, they erroneously believed that success in both investing and gambling was equally up to chance.
Studies 2, 3, and 4 were conducted to assess the differences in loss aversion between gambling-framed and investment-framed tasks. In Study 2, participants indicated the lowest possible gain they would be willing to accept with a 50% chance of losing their initial money. In Study 3, participants had to decide to accept or reject multiple hypothetical ‘gambles’ (or ‘investments’, depending on the condition) in which the amount of money they were at risk of losing varied. Study 4 was a replication of Study 3 but used the real-world labels ‘stocks’ and ‘lottery tickets’ instead of calling them investments and gambles.
Across all three studies, the researchers found evidence of greater loss aversion in gambling-framed conditions over investment-framed conditions.
In Study 5, the researchers assessed the emotional intensity of gains and losses from decisions framed as investments or gambles on a 100-point scale from “no affective reaction” to “very unhappy” (or “very happy”, depending on if it was regarding a loss or a gain). Again, results supported the hypothesis – people had stronger negative reactions to gambling-framed losses than to investment-framed losses.
Finally, in Study 6, participants were invited to make real ‘investment’ or ‘gambling’ decisions with real rewards on the line. Participants were initially given ¥10 as compensation for a prior task and then were primed to think about gambling or investing. Like Study 5, they were asked to rate how they would feel if they won or lost ¥5 on the task. Then, they were asked if they wanted to put their previous earnings at risk to participate in the real task.
The researchers found that significantly more participants were unwilling to participate in the gambling condition (62.24% of participants) than in the investment condition (37.84% of participants) suggesting the presence of greater loss aversion towards gambling.
Taken together, these findings suggest that people are less bothered by financial losses stemming from risky investments. On the flip side, people know that gambling usually leads to losses, so when they do take part and lose, it stings that much more.