The behavioral deals of finance deal with psychological side of decisions that are made for the financial aspects. One of the most important concepts which relate to how the people approach finance is regret aversion. You should be aware about it and you should also have enough knowledge about how to deal with it.
Have you avoided or stalled about deciding on something? Were you skeptical about regretting the decision that you made? Have you placed all your money in bank instead of investing it in a place where it is more risk because you were scared that you would regret it later?
These are all common mistakes and you aren’t alone. It is called regret aversion and you basically avoid making any financial decisions or don’t go anywhere except the ultra safe route just because you might lose everything. You have aversion for regretting.
This can be good in some context but mostly, it will prevent you from making optimal decisions and you will start behaving in a manner that is ultra conservative. A lot of people tend to steer clear of the important decisions in their portfolio for making wrong decision.
A lot of times, you find it hard to make the right decisions because your head isn’t in the right place. This might make you conservative and risk averse and hence you might not get the expected returns out of your investment. After the inflation and taxes, the actual returns that you get might be less than what you were looking for the in the first place. You should understand that you might be wrong about a lot of things in short term but as horizon of the time increases, you’ll be right more frequently.
It is recommended that you diversify; this will divide your decision in to smaller ones and you might find investment less risky in this way. You can also consult any trusted financial advisor.
The sub optimal choices because of regret aversion bias are as follows –
The investors often choose investments that are less risky like fixed maturity bond funds or term deposits. This can lead to the sub optimal returns due to the fact that such investments run risk of high inflation – there is a risk that the returns won’t be enough for countering rise in the level of prices.
Investors don’t sell profitable positions fearing that they might be forgoing the up side potential. It is often seen that riding the winners with out any trading plan is a bit risky because the stock can reverse the direction and then wipe out all the gains that are unrealized.
Regret aversion also forces the investors to the herd. Rationale here is that market can’t be wrong. Apart from that, if investment is doing wrong turn then the investor can console himself saying that she wasn’t the only one who ran in to trouble.
There are also chances that the investors who are suffering from the problem of regret aversion will turn coy over markets that have sharply declined. They fear that regret will be higher if market further goes down. In this process, they some times fail in seizing the opportunities for buying more stocks at bargain costs.
Finally, the investors prefer investing in the mature companies and large caps. Reason here is that high-growth smaller companies are more risky. A lot of risk might give you higher returns but on the other side, it might fetch you higher regret.
