Personal Finance Essentials
Regret Avoidance Bias
The Psychology of Investing > Regret Avoidance Bias
Regret means wishing you hadn’t done what you did. It’s one of the worst feelings we experience – and we’ll do almost anything to avoid it.
Consider experiments where people were given a $1 lottery ticket or a dollar bill. Everyone was offered the option of switching – and almost no one did. Those who received lottery tickets figured the ticket might win, and they’d regret trading it for a dollar. Those who received dollars figured the ticket would prove worthless. In each case, everyone wanted to avoid the risk of regretting a bad decision – so they defaulted to doing nothing. This is why people often refrain from investing: they want to avoid the regret from a losing investment more than they want the pleasure of owning a winning one. Dollar cost averaging can help reduce that fear by removing the need to time any single decision.
The Mathematics of Holding On
Regret avoidance causes investors to hold losing positions far too long. Consider an investment that has fallen 50% – from $1,000 to $500. Selling would force you to admit you made a mistake, and that causes regret. But the investment must now gain 100% just to return to where it started. The feeling that “I haven’t lost anything until I sell” is an illusion. The loss has already occurred – in the market, in your net worth, and in the opportunity you’ve forfeited. Refusing to act while a better investment waits may delay your financial recovery for years.