Rise Above The Feelings Of Regret

Being honest about your personal flaws will allow you to build a portfolio you can live with

- Graham Witcomb

There are two ways that forecasting is useful in investing. The first is in making successful predictions about an industry or a specific company’s outlook. The second is in making honest predictions about yourself.

A 2015 study found that over the previous 20 years, the average US mutual fund investor earned a return of 4.7% compared with the market return of 8.2% – a gap of 3.5%. Almost half the underperformance was due to “voluntary investor behaviour” – panic selling, exuberant buying and trying to time the market.

“No evidence has been found to link predictably poor investment recommendations to investor underperformance,” the researchers said. “Analysis of the underperformance shows that investor behaviour is the number one cause, with fees being the second leading cause.”

Psychologist Daniel Kahneman has said that “regret is probably the greatest enemy of good decision making in personal finance”. Kahneman won the Nobel Prize for his work on “prospect theory”, a descendent of which is “regret theory” – that our fear of regret (ie, losses) is felt more strongly than the anticipation of gains. We tend to overestimate how much regret a decision could lead to, which biases our choices.

When the market is down, anticipated regret can prompt you to panic-sell at the bottom. When things are going well, a fear of missing out might encourage you to buy at excessive valuations or put too much of your money at stake.

Anticipated regret is also why we tend to focus on sunk costs, rather than make each new decision on its own merit. If a stock has been doing well for us, we tend to shop around less for the next bargain, preferring to stand by our earlier commitment.