Regret aversion—2-minute video

Is Regret aversion bias affecting your clients? Help them find out by sharing this short, client-approved video, which provides actionable insights and guidance on how the Regret aversion bias can potentially influence our investment decisions. Then consider exploring the behavioral finance program for advisors linked near the bottom of the page for follow-up tools.

Regret aversion bias in perspective

How clients can make impulsive decisions—or avoid deciding entirely—to avoid regret.

Key Takeaways:

• Regret aversion bias is the tendency to choose the option that seems to carry the lowest potential for regret.
• This bias may trigger action avoidance or decision paralysis among your clients, or even hasty decision making, potentially damaging their long-term performance results.
• Considering a decision in isolation, rather than considering how the decision fits into a broader investment strategy, can sometimes be a catalyst for this behavior.
• Clients may also be overestimating how much regret they might feel, leading them to hold too much cash, or to avoid rebalancing, cutting losses, or taking profits.
• Educating clients about the risks of regret aversion bias can help them develop a disciplined approach to investing focused on their long-term wants and needs.

What is regret aversion bias?

Regret aversion bias is the tendency to act—or avoid acting—based on whether the action might lead to regret. For clients, regret aversion bias may lead to weighing the potential emotional pain of experiencing a loss. In fact, regret aversion is closely related to the fear of missing out, or FOMO, where the anxiety of missing out can potentially overpower rational decision making.

As one example of this behavior, in early 2020 as the COVID-19 pandemic fueled global panic, the S&P 500® Index dropped more than 30% from earlier in the year. At this point, investors affected by the regret aversion bias may have concluded that they’d heavily regret staying invested if stocks continued to fall, leading them to cash out of the market. Unfortunately, these investors may have subsequently stayed overallocated to cash and avoided getting back into stocks even after they had bottomed. This means they would have missed out on at least some of the market’s 18.4% gains for the year.

At a glance: Regret aversion

Regret aversion bias is emotional. It describes the tendency to make decisions based on perceived likelihood of future regret.

People with regret aversion may be tempted to avoid risk by holding more cash or cash equivalents in their portfolio. However, the stock market has outperformed cash over the long run.

Stocks have outperformed cash, historically

Growth of $100 invested in the S&P 500 and 3-month Treasury Bills (T. Bills) in 1963.¹

Inflation causes cash to lose its value over time²

Purchasing power of $1 in 1982 dollars

The problem: Holding too much cash increases risk over time. It could lead to significantly lower returns and cause investors to have trouble keeping pace with inflation.

How advisors can help: Help clients focus on long-term market movements and set guidelines that determine when to buy, sell, and hold investments.

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¹https://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/histretSP.html
 ² U.S. Bureau of Labor Statistics; Schwab Asset Management®. Inflation represented by the CPI starting in 1980; 2024 data estimated based on the CPI change from Q2’23 to Q2’24.

Why does it matter?

Regret is a negative emotion. According to Daniel Kahneman and Amos Tversky’s prospect theory, people typically exhibit heightened sensitivity to negative events compared to positive ones.¹ As a result, they might be more focused on trying to avoid outcomes that could potentially trigger regret, acting in ways that may end up harming their long-term interests.

For instance, regret aversion bias has the potential to trigger rash decision making, such as investing in a hot stock—even though doing so might mean buying at a high point—purely for fear of missing out on potential future gains. On the other hand, your clients may also want to hold onto stocks whose fundamentals and value have fallen and no longer seem appealing, fearing that selling the securities would lock in losses and ensure disappointment.

Regret aversion bias can also lead to other challenges for clients. Concern about making a “bad” choice is one such example. Too much concern about making a bad choice can lead to investment paralysis, preventing them from acting when necessary.

Unfortunately, the negative effects of regret aversion bias are often magnified when your clients face important decisions. A person is much more likely to worry about buying the wrong house than selecting the wrong movie to watch. As a result, the negative effects of regret aversion bias can feel most pronounced when your clients are facing their most-consequential financial decisions.

What can you do about it?

Regret aversion bias is an emotional bias based on instinctive reactions, gut feelings, and a fear of pain. Because this bias is based on how an individual expects to feel rather than based on what they think, it’s important to use techniques that can potentially help diffuse the emotional intensity of regret aversion bias.

Grounding clients in data about long-term market movements is one value-added technique that advisors might adopt. For example, providing specific examples of past financial bubbles and subsequent market recoveries. Or, sharing data on the tendency of stocks to grow over the long term, despite short-term fluctuations.

Setting objective trading guidelines for clients around buying, selling, and rebalancing is another potential mitigation strategy. For example, advisors might require a waiting period before clients act to avoid rash decision making. Or advisors might set specific rules that trigger actions, such as rebalancing a portfolio only when it has shifted a certain percentage away from its target allocations. Rules like these can potentially give your clients confidence in their actions and deepen your relationship as their trusted advisor.

Omar Aguilar, Ph.D.
President, Chief Executive Officer, and Chief Investment Officer