What is... | May 29, 2012

What is regret aversion?

Have you ever heard people say you regret more the things you don't do? Yet there can be even more fallout from bad decisions.


Imagine you decided to sell a share and then it rose in price. You might have felt regret from selling at the time but beware: the fallout could intensify as you try to avoid more pain in the future. According to behavioural economists, the next time you considered selling or buying you might be biased. Not selling may appeal more, the theory goes, because we typically feel more regret about things we have actually done – as opposed to actions we have not taken.

We might try to minimise regret by not acting. This tendency to avoid taking an action due to fear that 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 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 lots of financial decisions that could cause regret – yet it is not always financially sensible to do nothing.

Safety first
Investors often face a choice between investments with a low risk of loss but only small potential gains or higher risk ones that could earn bigger 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. Sometimes this regret aversion can make it more difficult to earn high enough returns to meet long-term goals.

Or instead of taking decisions themselves, investors may copy others’ investment strategies, even when they're not suitable for their specific circumstances. Copying others in this way may create less regret than suffering a loss on an unpopular investment.

Move on
At its worst, regret aversion can prevent people from doing anything, for fear their decisions will turn out wrong. This tendency not to take any action is known as the “status quo bias” . This can be especially harmful if it means people do not pay attention to their financial position. Losses can mount and financial security can be destroyed.

Nice premium
Paying attention to budgeting and long-term financial planning can be one way to avoid the potential effects of regret aversion. When decision making is difficult, it can make good sense to talk to people with more 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 situation is complicated.

Investing

eZonomics team
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