Regret aversion bias. Complete avoidance of investment risks is as harmful as excessive risk-taking.

Regret aversion bias causes investors to make wrong decisions out of fear of regret. They may hold onto losing positions or avoid selling winners, leading to irrational and risky behaviour. Discover whether you are prone to a regret aversion bias and the extent to which it affects your investment decisions with PRAAMS BehaviouRisk.

Behavioural science. What is regret aversion bias?

This behavioural pattern results in people avoiding regret and consequently making the wrong investment decisions. For example, an investor who has experienced losses in asset allocation is likely to abstain from active investing for some time, intimidated by the fear of making the wrong decision again. The reverse is also true. An investor who saw his portfolio jump in value may be unwilling to fix the profit because it could be a mistake should the growth continue. 

Regret aversion bias is an emotional bias, i.e., an error in emotional reactions. These biases are more difficult to overcome and require permanent discipline and control in addition to awareness.

What are the consequences and portfolio risks?

This behavioural finance bias typically manifests in staying too long in both ‘losing’ and ‘winning’ positions. Investors abstain from selling losers to avoid admitting that they made a mistake in risk analysis and thereby avert the associated regrets. Similarly, investors refrain from selling winners as they do not want to miss out on further growth and then regret it. Both types of behaviour are irrational and risky, leading to excessive losses and missed opportunities over time. Another facet of this bias is excessively risk-averse behaviour after experiencing losses, or concerning trade ideas that have recently devalued. Insufficient risk appetite undermines investment objectives. Finally, investors prone to this bias may find it easier to invest in risky assets if they know that many others have done the same. ‘Meme’ stocks are a good example. Here, investors feel that their investment decision is good because many other investors have invested too. As such, even if it turns out to be a poor decision, they will not be alone in regretting it, which in theory, may alleviate some of their remorse. 

What can I do to make my portfolio optimal? 

Regret aversion bias is widespread among investors. The good news is that experienced, risk-aware, self-disciplined investors are less prone to its adverse consequences. Key to overcoming this bias is spotting its manifestations, which are centred on the fears associated with making investment decisions. Among these are the general unwillingness to invest in risky assets – even if they suit your investment risk tolerance – as the chance of making a bad decision is higher. Fear of making a mistake results in taking no action at all, and holding a position for too long while incurring losses may trigger fears of investing altogether. 

No decent return comes without risk, and risk avoidance is as harmful as excessive risk-taking. The financial market is inherently cyclical, and the chances are that a spike will follow a dip, and if not invested, you will miss it. Losing is an unavoidable part of investing, and no successful long-term investor has only ‘winners’ in his portfolio. Successful investing is more profit than loss, not zero loss. No one can always be right about market timing, and no one can perfectly predict stock direction. Consequently, mistakes are inevitable, and it is ok to make them. Similarly, it is ok to sell winners before they reach their peak, and it is ok to buy falling stocks before they reach their bottom. What is not ok is standing still precisely when action is needed.