Regret Aversion: How Fear of Being Wrong May Shape Financial Choices

We might think that investors make decisions based solely on rationale and numbers. However, they are often influenced by human emotions, even in the financial realm. One strong emotional variable is known as regret aversion, the fear of future regret over a potentially wrong decision made today.

In investing, this fear of regret may result in inaction, deferred decisions, and choices that might prioritise avoiding regret rather than producing potentially optimal outcomes.

In this article, we analyse the meaning of regret aversion and its impact on financial decisions, as well as what steps may help investors lessen its influence.

Table of contents

• What is regret aversion?
• Why regret aversion matters in investing
• Evidence and context
• How regret aversion may shape specific financial choices
• Strategies that may help overcome regret aversion
• Limitations and cautions
• Illustrative example (hypothetical)

What is regret aversion?

In behavioural finance, regret aversion (or anticipated regret) refers to how people anticipate the negative emotion of regret and let that anticipation influence their choices. In simple terms: rather than only weighing potential gains or losses, they might think along the lines of - “If this goes wrong later, I’ll regret it.”

This means investors may avoid actions that, in hindsight, might be judged harshly, even if those actions may be rational based on the available information in the present. Within behavioural finance, regret aversion is a recognised bias. It may lead to inaction (doing nothing), or conversely, to taking decisions driven by emotion rather than analysis.

Read Also: How Behavioural Nudges Help Financial Decisions

Why regret aversion matters in investing

• Paralysis and inaction: If an investor fears regret, they may delay or avoid making a decision like buying, switching funds, rebalancing, etc. This approach may potentially lead to missed opportunities: markets evolve, and staying put may itself carry risk.
• Disposition effect and holding losses: Regret aversion contributes to the disposition effect, the tendency to sell assets that may have appreciated while holding onto those that have declined. Investors may avoid admitting a loss (which would confirm they were wrong) and thus retain losing positions hoping they will recover.
• Herding and comparing with others: When individuals fear being judged for a wrong move, they may follow the crowd. Copying what others are doing might feel less risky than standing out and possibly being blamed if things go wrong. This behaviour is often tied to regret aversion.
• Overcommitment to poor investments: Because exiting an investment might confirm a “mistake”, investors may pour more money into a failing investment in the hope of proving themselves right. This is sometimes called “throwing good money after bad”––a behaviour linked to regret avoidance.

Evidence and context

Studies conducted in various markets have shown that regret aversion is an important predictor of investor behaviour. It interacts with risk tolerance, as well as demographic factors including age, gender and income.

In a study conducted in the Indian market among individual investors, regret aversion (alongside herding behaviour and loss aversion) emerged as one of the salient biases affecting investors' decisions.

These findings suggest that regret aversion is not merely theoretical, it is active in real markets.

How regret aversion may shape specific financial choices

• Choosing stability over return potential: Regret-averse investors may lean toward the more familiar choice, even if the riskier option may have higher upside potential.
• Holding assets too long: As noted, loss-making investments may be held far longer than logic would suggest, because selling might confirm the regret of being wrong.
• Skewed rebalancing: Instead of rebalancing a portfolio, investors might avoid these moves to avoid regret if the “new” choice potentially underperforms.
• Avoiding new investments: Fear of regret may deter investors from trying new asset classes or sectors. Investors may stick to what’s familiar, even if diversification might potentially benefit them.

Read Also: Confirmation Bias: Behavioural Finance and Mutual Funds

Strategies that may help overcome regret aversion

• Create rules or frameworks: Premade decision rules might help mitigate emotional interference. For example, you may establish your criteria in advance for when you plan to sell, rebalance or review. This approach could create a mechanical process and might also reduce the emotional burden associated with making decisions.
• Anchor to goals and time horizon: Connecting your choices to long-term goals (like retirement, or your child’s education) might make short-term regrets feel less burdensome. Thinking in terms of long-term time horizons may help mitigate the doubts in the moment.
• Scenario thinking: Instead of worrying about the worst-case outcome, focussing on the more likely potential results of your decision and how probable they are might help mitigate fears.
• Diversification and smaller bets: By investing in small allocations in a space you are not familiar with and not going all in, you might limit your regret if that sector potentially underperforms.
• Review and learn: Periodic reviewing of your decisions (regardless of if they are positive or negative) might develop resilience. Accepting that the decisions you make might underperform, and gaining insight from those decisions could help mitigate anticipatory regret.
• Seek external accountability: Employing an adviser or sharing your investing strategy with a trusted peer may help reduce the weight of the regret. An external source of feedback might be valuable.

Limitations and cautions

• Not the only bias at play: Regret aversion might often occur along with loss aversion, overconfidence, anchoring and herding. It rarely acts in isolation.
• Bias versus context sensitivity: In some cases, avoiding regret might be rational (e.g., when uncertainty is extreme). Total dismissal of regret aversion may not be sensible.
• Individual variation: The intensity of regret aversion might differ by personality, age, education and prior experience.

Illustrative example (hypothetical)

Imagine an investor is considering shifting 20% of a portfolio from a debt fund to an equity fund, anticipating higher potential returns. But they fear that if they switch and equity performs poorly, they’ll regret the decision. So they postpone or avoid the shift entirely. Meanwhile, equity rallies and the portfolio lags. In hindsight the investor sees the opportunity cost of delay and the regret of not acting.

If they had predefined that “every year, I will evaluate moving up to 20% to equity if valuation conditions are favourable”, the decision would have become less emotional, and they would have avoided being rendered inactive by “what if.”

*Example for illustrative purposes only.

Conclusion

Regret aversion is an emotional filter through which many investors may interpret choices. Rather than purely weighing potential returns and risks, they may allow the fear of being wrong to guide moves. This may lead to inaction, overhold of losses, and less experimentation. You might be able to mitigate its effects by using rules, anchoring to goals, embracing small allocations, and building a tolerance for occasional underperformance.

At Bajaj Finserv AMC, we recognise that emotions are the cornerstone of investor behaviour – not just for investors but for investment professionals too. That’s why, behavioural finance is at the heart of our investment philosophy, InQuBe, which combines the Information Edge, Quantitative Edge and Behavioural Edge. By understanding, tracking and monitoring market sentiments and our own investment biases, we seek to make mindful and strategic investment decisions. Get the Behavioural edge by investing with Bajaj Finserv AMC. Read more about InQuBe here.

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