Regret aversion: why you may want to bet against your own team
The World Cup is now behind us but the emotional ups and downs of following your national team allow us to draw parallels with investing behaviour.
Leading up to the semi-final game where England played Croatia, some of our colleagues were discussing the idea of placing a bet on Croatia to win, despite wanting England to succeed. That way if England did not win they would still get some pay-off from the game. Unbeknownst to them, they were discussing an idea from behavioural economics called Regret Theory.
Regret Theory says that people care not only about what they get from the decision they make, but also about what they would have gotten if they had chosen differently. It suggests that we make choices that attempt to minimize the regret associated with thinking ‘what could have been’.
In the case of our colleagues, they recognised that instead of betting on England, betting against them meant they would have something to console themselves with in either outcome.
Fear of missing out
You may have found yourself minimising regret in other areas of your daily life. Have you ever found yourself ordering the same dish as your fellow diners in a restaurant to avoid food envy? Or have you agreed to order differently and share dishes? If you have then you’ve exhibited regret aversion.
This regret-avoiding behaviour is not just limited to our culinary choices, but is also apparent in investing. Regret avoidance can provide a good explanation for why people tend to follow the decisions of others and find comfort in crowds, known as ‘herding’.
We don’t want to experience the regret of missing out on an investment which produces exceptional returns – particularly if a friend captures those returns. As a recent example, this may explain some of the popularity of investing in cryptocurrencies like bitcoin.
As investors, it’s important for us to understand how regret may influence our behaviour.
There is a positive side, and we can use regret to encourage good investing behaviour. Our investment philosophy is built around diversifying your portfolio across and within asset classes, which, as well as being a sensible approach to risk management, should also help to reduce any regret of missing out on the performance of the best asset classes.
But beware of the negative effects of regret: it can also lure us into making investment decisions driven purely by a fear of missing out, and leave us exposed to investment bubbles if we see others making the kind of investment returns we envy.
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