Regret Aversion

Applicable in:

When making decisions, one should consider all outcomes, the likelihood and effect of each outcome, and make a choice based on that. What people really do is often different. They think about the worst possible outcome, and how they would feel about that outcome (their level of regret). They then choose the option that minimizes regret, even if it is not optimal. This often leads to less risk-taking, as risks increase the maximum potential regret. For this reason, regret aversion is closely linked to risk aversion. It is important to differentiate between regret and disappointment. Regret describes displeasure with the current state related to one’s actions, while disappointment describes displeasure with the current state related to circumstance or luck. People tend to be much more averse to the further than the latter, and their actions are different as a result.

When picking stocks, one should consider the likelihood of it rising and falling, and the harm and gain that each would cause. What most people do is different. They consider how bad it would feel if the stock did as poorly as they could imagine it doing, and attempt to minimize that feeling. This leads to incorrectly risk-averse strategies.

Used In