“Regret theory suggests investors who sell at the wrong time and miss out on gains experience regret that affects their judgment, leading to subsequent market-timing mistakes,” says Sarah Newcomb, behavioral economist for research firm Morningstar and author of the book “Loaded: Money, Psychology, and How to Get Ahead Without Leaving Your Values Behind.”
Reading this quote made me remember a saying we used to repeat in my Fidelity days. “There are two emotions that drive investors – fear and greed.” We should have added to that the emotion of regret.
Regret Theory can inhibit a person’s rational behavior, leading to decisions that can harm, rather than help him.*
Here are some examples:
- In rapidly rising markets, regret theory can make a person feel FOMO (fear of missing out), compelling the investor to take risks they shouldn’t.
- After having sold investments at a low time and watched the markets go back up (typically while sitting in cash), an investor with regret is often paralyzed and can’t undo his earlier bad decision. This compounds the earlier decision to sell by continuing to miss out on growth in the markets.
How can you avoid being a case study for Regret Theory? When tempted to make a big change in your investments that seems out of character, try these things:
- Call your financial advisor!
- Try the 10/10/10/10 rule: How will this decision make me feel in 10 minutes? In 10 days? In 10 months? In 10 years?
And remember, when investments are going crazy, often the best action is the hardest: Sit tight and do nothing.