Regret Aversion

Regret aversion occurs via fear of either commission or omission.¹ In other words, it is the prospect of committing to a failure or omitting an opportunity that we seek to avoid. The concern of committing to a failure, for example, such as making a bad investment, can loom over one’s preferences. People sometimes think less about making a good decision and more about avoiding a bad one. This anticipation of regret over making the wrong choice is often factored into our decision-making as a form of emotional insurance.

Regret aversion can also have positive effects, where potential regret can act as a motivator in engaging in healthy behaviors such as exercise.² For those who exercise, the sense of “if I don’t go to the gym now, I know I’ll regret it later,” might be all too familiar. So, while cognitive biases often highlight people’s tendencies to prioritize the present over the future, regret aversion emerges as a caveat where potential regret can guide a decision where a future state is prioritized - we don’t want our future self to experience regret, even if it means sacrificing present consumption. This could actually motivate individuals to save more, as they may seek to eliminate the possibility of regretting not having saved at some future date.

If regret aversion can occur among individual investors, it can, in turn, impact the broader financial market. Investors may buy a stock because they don’t want to regret missing out on the opportunity, or they might sell a stock prematurely because they don’t want to regret having committed to holding. These decisions can in turn affect the price of a stock. Overbidding in auctions, for example, is a result of bidders considering regret in addition to profit and driving the price up, which has been attributed to regret aversion.³

Personal responsibility is central to regret aversion as, by definition, one can’t regret a decision that they have no control over. Therefore, the bias predominantly occurs in people considering their own decisions, with collective effects emerging only when those individual sentiments create an aggregated outcome, such as in the case of financial markets.

Support for the emotional component of regret aversion can be found in neuroscientific studies, which suggest that anticipated regret’s powerful influence on future decisions is a function of our emotional pathways in the brain. One study associated regret aversion with increased activity in the orbitofrontal cortex and the amygdala,⁴ a connection that is believed to be highly involved in emotional processing.⁵

Moreover, as Daniel Kahneman and Amos Tversky’s renowned prospect theory states,⁶ people are more sensitive to negative than positive events. With regret manifesting in negative emotion, we learn over time that this is an aversive outcome, and seek to eschew the possibility. As with many cognitive biases, our preferences are derived from how we feel about a prospect rather than what we think about it.

Regret aversion is likely to be even stronger in decisions with significant consequences. While we may factor in regret when choosing between menu items at a restaurant, this regret will likely not loom as much as the potential regret over choosing the wrong house. This makes regret aversion a non-trivial bias, as it can impact high stakes decisions.

Aside from its influence, the ability of the bias to help or hinder depends on the context. As previously mentioned, regret aversion can increase positive health-related behaviors,⁷ but also result in irrational decision-making in investing.

One particular study found that people often overestimate future regret,⁹ which suggests that individuals are less susceptible to regret than they may believe. This is an interesting finding to keep in mind when considering a decision where potential regret is influencing our preferences, where we can note that it may not be as likely as we think.

Apart from the outcome, it can also help to take a more Buddhist approach in trying to avoid regret altogether, not by adjusting decisions, but by accepting outcomes. Whatever happened in the past is out of our scope in terms of impact. We can’t reverse our decisions of yesteryear but we can adjust our perspective towards them and seek to minimize the discomfort of regret.

A number of studies emerged in the early ’80s suggesting a role of regret in traditional economic theory. In 1982 for example, Graham Loomes and Robert Sugden published Regret Theory: an Alternative Theory of Rational Choice under Uncertainty.¹⁰ They noted how the “basic axioms” that underlie classic economic models, such as expected utility theory, don’t always align with human behavior.

Have you ever heard someone say they have bad FOMO? Sometimes what they are saying, essentially, is that they are highly susceptible to regret aversion. FOMO often occurs when people make a decision out of a fear of missing out on the opportunity, as they might regret their decision at a later date.

Consider a hypothetical scenario. It’s Friday night and Sarah is quite comfortable to be staying in and watching a movie with some popcorn when one of her friends calls her and asks if she wants to go to a party. Although Sarah is quite tired and perfectly content staying in, the fear of missing out looms large as she doesn’t want to regret not going to the party. What if it’s a great party? This anticipated regret drives Sarah to put the popcorn back in the cupboard and get ready.

Prize winners for the Dutch postal code lottery, the largest charity lottery in the Netherlands, are the individuals who bought a ticket and reside under the postal code drawn. This means that people who didn’t buy a ticket would be made aware of whether they would have won or not after the postal code has been drawn.

Despite playing the lottery being an “irrational” behavior, it is believed that anticipated regret drives many of the decisions to buy one of these Dutch lottery tickets, as people are averse to the prospect of having their postal code drawn and going away empty-handed.

What it is

Regret aversion is when the anticipation of regret is factored into a decision, leading us to a preference that minimizes potential regret.

Why it happens

Regret manifests in the emotional circuitry of the brain, which is relied upon in gauging one’s preferences during decision-making. Since losses loom larger than gains, we seek to reduce the likelihood of incurring the negative experience of regret.

Example 1 - Fear of missing out (FOMO)

Sometimes people choose to go to that party not necessarily because it seems like fun, but because by not going, the possibility of regretting not going may weigh on one’s conscious.

Example 2 - The Dutch postal code lottery

A lottery where people who didn’t participate are made aware of whether they would’ve won garners more interest as people don’t want to be put in the situation where they’re left regretting not buying a lottery ticket after their postal code was drawn.

How to avoid it

Acknowledging that we overestimate the likelihood of regret can help curb runaway regret aversion. Additionally, accepting outcomes as they are rather than dwelling in regret can make some prospects less aversive in the future.

What Can George Costanza Teach us About Making Better Investment Choices?

This article summarizes how the disposition effect, a phenomenon within behavioral finance closely linked to regret aversion, plays a role in financial decision-making.

Increasing the Pull of the Future Self

This article provides a nice caveat to regret aversion, as it highlights the many ways we fail to account for what our future selves might prefer.