You might have felt regret from selling at the time but – beware – the fallout could multiply as you try to avoid more pain in the future.
According to “regret aversion”, the next time you considered selling or buying you might be biased. Not selling may seem more appealing, as, the theory goes, we feel more regret about actions we did take than actions we did not take. We could try to minimise regret by not acting.
The tendency to avoid taking an action due to fear that, in hindsight, it will turn out to have been the worse option is known as “regret aversion”.
Don’t look back
No one likes losing money and as experiments cited in the eZonomics article What is... loss aversion suggest, the pain of a financial loss can be twice the pleasure associated with an equivalent gain.
Regret aversion means people avoid or delay taking decisions that might lead to them suffering a loss.
The problem is that there are a large number of financial decisions that people regularly face that have the potential for regret – and it is not always financially sensible to “do nothing”.
Investors often face a choice between investments with a low risk of loss but only small potential gains or higher-risk with the chance of greater rewards.
When considering whether to increase financial risk, fears of potential losses and regrets could mean investors stay with lower risk (and lower return) investments. The effects of this can be wide ranging. In some circumstances, this regret aversion can mean it is difficult to earn high enough returns to meet long-term goals.
Or instead of taking decisions themselves, investors may copy others’ investment strategies (despite it not being the best fit for their circumstances). Taking the same decision as others may create less regret than suffering a loss on an unpopular investment.
At its worst, regret aversion can prevent people from taking any decision for fear it will turn out wrong. This tendency not to take any action is known as the “status quo bias” .
This tendency to inaction can be especially harmful as it can lead to people not paying attention to their financial position. Losses can mount and financial security becomes a hostage merely of chance.
Overall, the best way for households to avoid being adversely affected by regret aversion could be to pay attention to budgeting and long term financial planning.
In cases where people find it difficult to make a decision, it can make good financial sense to talk to people with experience in money matters. While many turn to friends and family for advice, it might pay to turn to a professional adviser or bank for advice, especially if the financial matter is complicated.
Clarity Economics’ lead consultant