Regret aversion in investing: how fear of regret leads to worse decisions

Regret aversion is the tendency to make decisions in ways that minimise the anticipated pain of regret—even when those decisions reduce expected return. Investors affected by regret aversion avoid actions that could turn out to have been wrong, hold positions past the point of rational exit to avoid crystallising a decision they might later second-guess, and gravitate towards consensus positions where the social cost of being wrong is lower. The result is a consistent distortion of portfolio decisions away from what the evidence suggests.

What regret aversion is

Bell (1982) and Loomes and Sugden (1982) introduced regret theory as a formal alternative to expected utility theory, observing that the anticipation of regret influences choices in ways that cannot be explained by standard models. Regret is distinct from disappointment: disappointment is the feeling when an outcome is worse than expected; regret requires the counterfactual—the awareness that a different decision would have produced a better outcome. The pain of regret is not just about the loss; it is about the responsibility for the loss.

Gilovich and Medvec (1995) found that the temporal pattern of regret is asymmetric. In the short run, people regret actions (things they did) more than inactions (things they failed to do)—the immediate pain of a bad active decision is sharper than the muted feeling of a missed opportunity. Over the long run, however, this pattern reverses: people come to regret inactions far more than actions, because the things they failed to do become the source of a persistent, unresolved sense of having left value on the table. For investors, this means the fear that drives regret aversion is systematically misaligned with where regret is ultimately felt most acutely.

How it manifests in investing

Regret aversion produces several identifiable patterns. Holding losers beyond rational exit is one of the most common: selling a losing position makes the decision permanent and attributable. Continuing to hold preserves the possibility of recovery and diffuses the sense of personal responsibility—the market might yet vindicate the original decision. This is closely related to the sunk cost fallacy and the disposition effect, and it is reinforced by loss aversion. See the sunk cost fallacy in investing for a detailed examination of this mechanism.

Regret aversion also generates herding behaviour. An investor who deviates from the consensus allocation and is wrong will feel the full weight of personal responsibility for the loss. An investor who holds the same portfolio as everyone else and experiences the same loss can attribute it to circumstances beyond individual control. This asymmetry in how regret is assigned makes consensus positions psychologically safer, even when they are not the best risk-adjusted choice. The result is that regret-averse investors tend to cluster around benchmarks and popular assets rather than constructing genuinely independent portfolios.

A third pattern is paralysis at entry. Buying a prominent stock or asset class that has already risen substantially creates a fear of buying at the top—of being the last buyer before a reversal. This fear of entry regret leads some investors to wait indefinitely for a better price, forgoing a large part of the return available in the interim. Barber and Odean (2008) found that individual investors buy stocks that have recently been in the news—using attention as a filter to enter positions—rather than acting on forward-looking analysis, which is consistent with investors seeking a social justification for their entry timing.

The cost

The financial cost of regret aversion is difficult to isolate from related biases, but several of its channels have been quantified. The tendency to hold losers and sell winners—partly driven by regret aversion—produces the disposition effect, which Odean (1998) found reduced individual investor returns by approximately 3.4 percentage points per year relative to a simple buy-and-hold benchmark. The herding component of regret aversion contributes to momentum and to the eventual reversal when crowded positions unwind—both of which impose costs on the investors involved. The paralysis at entry compounds the cost of inaction that Gilovich and Medvec's long-run regret data suggests is ultimately more damaging than the short-run pain of a bad active decision.

What helps

The most effective structural defence against regret aversion is to move decision-making authority from the individual to a pre-committed system. When an investment strategy is specified in advance—which assets to hold, how to weight them, when to rebalance, and under what conditions to exit—the investor's role is to follow the system rather than to make the individual decisions that generate regret. A systematic strategy does not feel regret when it sells a position that subsequently recovers; the system evaluates each situation against its stated rules and acts accordingly. This architecture does not eliminate the emotional experience of watching a sold asset recover, but it removes the mechanism by which that experience feeds back into future decisions.

Related articles

• The sunk cost fallacy in investing: why past losses should not drive future decisions
• Loss aversion in investing: why losses hurt twice as much as gains help
• Herding behaviour in investing: how following the crowd amplifies market cycles
• Systematic vs discretionary investing: rules, flexibility, and the evidence on which wins