Subjective Gains and Losses

Subjective Gains and Losses

“Outcomes that are better than the reference points are gains. Below the reference point they are losses.”

 

Daniel Kahneman writes extensively about our subjective experiences of the world in his book Thinking Fast and Slow and about how those subjective experiences can have very serious consequences in our decisions, political stances, and beliefs about the world. One area he focuses on are reference points, our baseline beliefs and expectations about the world. As it turns out, our expectations can influence whether we think things are going well or going poorly, regardless of what the actual outcomes are. On top of that, we will make adjustments to our behavior based on what we expect in regard to those outcomes.

 

Kahneman continues, “When directly compared or weighted against each other, losses loom larger than gains. This asymmetry between the power of positive and negative expectations or experiences has an evolutionary history. Organisms that treat threats as more urgent than opportunities have a better chance to survive and reproduce.”

 

Without diving into the evolutionary psychology component of Kahneman’s quote (something that I normally would love to do) I want to focus on how complex our reality and decision making becomes when we predict outcomes, shape our behavior in response to those predictions, and bias those predictions based on personal reference points.

 

In the United States, two major economic indicators that are used by banks, economists, and the media for deciding whether we have a good economy or a poor economy are GDP growth and interest rates. Both of these measures are represented as percentages, both have specific targets that we have decided are good, and from both follow a set of decisions that we hope will improve the numbers in the direction we want to see. What is interesting, is that we have reference points for the numbers in terms of what percentages we believe reflect a strong and growing economy, and our subjective experience of the economy can be changed by those outcomes.

 

A 1% increase in GDP growth is growth in overall GDP, but to an economist, that growth is abysmal, and actions need to be taken to get that growth rate closer to 3 to 4%. At the same time, if expectations for GDP growth are only .8% and we hit the same 1% outcome, we might be very happy. In both situations, our decisions and behaviors might change based on the delta from our expected reference point and the final reference point. A gain can feel like a gain, but it can similarly feel like a loss depending on where exactly we placed our reference point.

 

Interest rates reflect similar dynamics, and might be even more complicated by more clear competing interests and desires in terms of interest rates. Banks might want to see higher interest rates, to earn more money, while people taking out loans may love the low interest rates. A 2% interest rate might feel like a huge loss to one entity, while simultaneously feel like a gain to another.

 

This creates strange competitive dynamics, because our brains hate losses. We generally need an expected or realized gain to be 2 times larger than a potential or realized loss before we will risk money or accept an outcome. If we have a certain reference point in mind for the outcome we want or would be happy with, we may need to see a large skew in a positive direction for us to be happy, while even a minor loss will feel disastrous.  (At this very moment in the United States this is what is taking place with the presidential election. Several journalists have noted that in December of 2019, the Democrats would be thrilled with the election outcome we have today, but many adjusted their reference point to a Biden landslide win, so a close win feels like a tragic loss – and somewhat of a win for Trump).

 

Reference points feel like a simple idea, but what I hope this post shows is that they can be hugely consequential, and incredibly complex, especially when we have multiple actors with multiple reference points all interacting on small and large issues. Choose your reference point carefully, and try to recognize when you are operating with a certain refence point in mind and be willing to adjust or discard it when necessary. Don’t let a win get wiped away because it ended up being slightly smaller than your reference point expectation.
Imaginary Reference Points

Imaginary Reference Points

My last post was about reference points and how they can create subjective experiences that differ from person to person. If my refence point is dramatically different than another person’s, then our experience of the same objective fact or reality can be quite different. If I suddenly won $1 million dollars my life might change dramatically, but if an incredibly wealthy person suddenly won $1 million, they might not care at all.

 

Reference points can get even more complicated than the example I just shared which was borrowed from yesterday’s post. Sometimes reference points don’t need to be real in order to shape our subjective experiences of the world. In his book Thinking Fast and Slow, Daniel Kahneman uses the example of an expected raise. If someone knows that their colleagues have received a raise, and expects to get a similar raise but does not, then they can feel as though they have really lost. Their financial situation has not changed, but they created an imaginary reference point in their mind which has shaped the way they think about their current situation.

 

We all have certain expectations about the world that we adopt as reference points. These reference points don’t have to reflect anything real about the world, but they can still greatly impact our subjective opinions and considerations of the world. They can be vain, such as how attractive we expect our spouse to be, or more positively aspirational, such as how much we expect everyone in society to participate in social causes to help those who are the most needy.  There is no real reference point that we are using, just hazy ideas of the way we think things should be, but nevertheless, these imaginary reference points can guide a lot of our thinking and behavior.

 

In my own life, examining these imaginary reference points has been incredibly helpful for making me a more happy and confident person. It is easy to let imaginary reference points fall to the background, where they run our lives without being considered in a critical way. By thinking deeply about our reference points we can better consider what we should and should not strive for, how much effort or money we need to put toward certain endeavors, and whether our behaviors are really reasonable and worthwhile. Through self-reflection and self-awareness we can recognize goals that serve as reference points which are unreasonable, desires which are vain and should be discarded, and ideas about who we are supposed to be that don’t truly align with our lives and what would help us live in a meaningful and fulfilling manner. Imaginary reference points matter, and they can greatly influence how we live our lives. We should make sure we think about them and let go of those which drive us in the wrong direction.
Subjective Reference Points

Subjective Reference Points

One reason why we will never be able to perfectly understand other people and the opinions, decisions, and beliefs that other people hold is because we all have different reference points. I cannot be inside your head, I cannot see things from exactly the same angle that you see things, and I cannot have the same background and experiences that you have. Our differing reference points create subjectivity in our lives, and not just in areas that we would all agree don’t have one true correct answer. Even areas where it seems like there should be a single objective fact or reality can be very subjective. We expect to see a lot of subjective variability in terms of our preferences for living in the city versus the country, in preferring private insurance versus state sponsored insurance, or preferring soft versus firm mattresses, but we probably don’t expect to have the same different subjective experiences or preferences for how loud a sound is, how light or dark a shade of gray appears, or the value of a $2 million dollar gambling win.

 

Each of these areas of unexpected subjectivity are discussed by Daniel Kahneman in his book Thinking Fast and Slow. He shows that understanding and predicting subjective experiences in these areas is possible if we understand the different reference points that are in play for each individual. There may be an objective and unchanging fact at the base of the reality each individual experiences, but the experience can nevertheless be subjective. Kahneman writes,

 

“To predict the subjective experience of loudness, it is not enough to know its absolute energy; you also need to know the reference sound to which it is automatically compared. Similarly, you need to know about the background before you can predict whether a gray patch on a page will appear dark or light. And you need to know the reference before you can predict the utility of an amount of wealth.”

 

I don’t want to end up in a point where we say there is no objective reality we can all observe, after all, “a dead body is a dead body, and someone is going to jail,” as a friend who is a federal judge here in Reno, NV once said to me. But I do want to highlight just how much of our world can be interpreted differently based on our reference points. Sounds, colors, and the value we would get from a certain amount of wealth are not obviously subjective, but Kahneman shows just how subjective these areas are in his book. This should make us consider how much our backgrounds, our unique points of view, and the circumstances in which we make our observations shape how we understand the world. A lot of our understandings of reality are context dependent, and that should cause us to pause before we say with absolute certainty that reality is exactly as we have experienced it. We should pause to consider the reference classes which shape and influence how we experienced the world, and how those references might be different than those of other people. We can’t just say that there is one way to interpret and experience everything in the world, we have to accept that how we experience the world will be shaped by many factors that we might not be aware of and might not consider if we don’t slow down to think about the references.