The Groupon Binky Effect:
“Hey, did you get that Groupon email for today? $25 for $50 worth at Nordstrom Rack!”
“No way! I’ll check it out when I get home after work.”
“You better check it out now because if they sell out, you can’t get the deal.”
“Shoot, you’re right. Let me call you back. I have an app for that.”
Every day, millions of people across 88 U.S. cities and 22 countries, make impulse buying decisions based on the fear of losing their binky.
In other words, if you’ve ever bought something from Groupon, you did so because it was a great deal (regardless if you needed it or not) AND because you had to decide immediately or else the deal would be gone forever – and no one likes to lose their binky.
In our research, we seek to understand the typical or average person’s pattern of thought and behavior. By setting a baseline, we understand what mistakes people in general are prone to making, and we can help prevent them from doing so. Buying a Groupon deal isn’t necessarily a mistake, but it’s the pattern of thinking that can cause people to get less out of their financial choices than they should.
Looking back at the Groupon example, we see that there are two options being presented: a) save $25 and lose the deal or b) get the deal and spend $25.
So what’s happening here?
Rather than saving $25 and locking in the gain, people are willing to spend $25 to avoid the perceived loss. This phenomenon is known as loss aversion.
Thomas Gilovich describes this as a “willingness to take more risk if it means avoiding a sure loss and to be more conservative when given the opportunity to lock in a sure gain.”
Here is his experiment that examined this behavior:
Imagine that you’ve just been given $1,000 and have been asked to choose between two options.
Option A: You are guaranteed to win another $500.
Option B: Flip a coin. Heads and you win another $1,000; tails and you get nothing more.
Which option do you choose?
* * *
Now imagine you’ve just been given $2,000 and have been asked to choose between two options.
Option A: You are guaranteed to lose $500.
Option B: Flip a coin. Heads and you lose $1,000;
tails and you lose nothing.
Which option do you choose?
According to research, people are more willing to lock in their $500 gain with Option A in the first scenario but would take a risk with Option B in the second scenario. However, both present the same situation: walk away with $1,500, or take a risk to get $2,000 with the downside potential of only getting $1,000.
Research by Daniel Kahneman and Amos Tversky shows that people feel nearly twice as strongly about the misery of losing $500 as they feel about the pleasure of gaining that same amount.
The Behavior Risk
This feeling or behavior isn’t inherently bad and being more conservative to not lose money can be a good thing – but having an oversensitivity to loss aversion can have negative consequences to your finances.
Take the recent market downturn for example. People who were overly sensitive to losses pulled their money out at the bottom and took years off their ability to retire and reach their goals. These people would rather not face the idea of taking on more short-term losses, even if that meant making a return in the long-term, because the pain is stronger than the gain.
They risk not reaching their long term goals in order to prevent losing any more in the short term.
Risk is Financial and Psychological
One of the most important decisions we make with Clients is evaluating their perceived vs. recognized risk tolerance. It’s one thing to ask how much risk they will take while in a cold state of mind (financial). Put them in a heightened emotional state and see how their answers change (psychological).
That’s not to say that we have screaming babies stress them out while asking about risk tolerance (although imagine how peoples’ opinions of disciplining children change under such conditions). We simulate stressful market and economic conditions to gauge behavior and also evaluate how they’ve reacted in the past.
What We Advise Our Clients
Even after our portfolios rebounded, we went back to a number of Clients to reassess their risk profile just to make sure we adjusted for sensitivity. Since we know people are overly sensitive to losing money, we encourage them to take on less risk in order to stay with their plans and portfolios. Getting an extra percentage return isn’t worth it if the downside risk would cause them to bail out.
On the other hand, some understand the irrationality involved with being overly conservative and take a more aggressive approach. Those with this risk tolerance are not the ones monitoring their portfolios daily, they are the ones focused on playing offense and ultimately, benefitting from higher returns.
It’s in our blood to stay intimate with your financial situation and emotional state, and our ability to help you bridge the two is what leads to financial success.
A Client recently complimented us and shared this with their friend:
“I never would have stayed in the market if it weren’t for these guys.”
Now that’s a binky worth holding onto.