Investors will feel regret if a wrong decision is made and will thereby consider this regret when making decisions
Over 1.8 million professionals use CFI to learn accounting, financial analysis, modeling and more. Start with a free account to explore 20+ always-free courses and hundreds of finance templates and cheat sheets.
What is Regret Theory?
Regret theory, studied in behavioral finance, is a concept stating that investors will feel regret if a wrong decision is made and thus will consider this anticipated regret when making investment decisions.
Regret theory can adversely impact an investor’s rational behavior, such as dissuading them from acting or motivating them to act. As a result, regret theory can impair an investor’s ability to make decisions that would be beneficial.
Summary
- Regret theory states that investors will feel regret if a wrong decision is made and will thereby consider this regret when making decisions.
- Regret theory can alter an investor’s risk profile, causing them to be more risk-averse or risk-seeking than normal.
- The fear of missing out is a byproduct of the regret theory.
Understanding Regret Theory
The fear of regret alters an investor’s risk profile, causing them to be more risk-averse or risk-seeking than they normally would be. For example:
Regret Theory Example: Being More Risk Seeking
Mike is a conservative investor who prefers to put his money into low beta stocks. Recently, he notices the meme stock craze that is unfolding in the financial markets, with numerous meme stocks surging by over 100%.
Mike further sees his colleagues purchasing meme stocks, and he decides to purchase some meme stocks himself, ignoring potential risks, to avoid the regret of not purchasing it if it runs up further.
Regret Theory Example: Being more Risk Adverse
Mike recently purchased a stock that caused him to incur losses even though he did adequate due diligence and research. To avoid the regret of losing money on further stock picks, Mike starts employing excessive caution and taking an abnormal amount of time to arrive at a conclusion for each investment decision.
Regret Theory: The Fear of Missing Out
The fear of missing out, also known as “FOMO,” is a byproduct of the regret theory. FOMO is used to describe a feeling of investor anxiety/regret that they are missing out on an exciting experience or important opportunity by not investing.
As a result, the investor would ignore their typical risk profile and buy into stocks (increasing their risk profile) for fear of missing out on a potential continued run-up in prices. FOMO can cause the most conservative and risk-averse investors to ignore warning signs of a bubble or imminent market crash.
Overcoming Regret Theory in Investing
Acknowledging and coming to terms with the fact that you are exhibiting signs of regret theory is a key first step. Investors can minimize regret theory in their investment decisions by following a disciplined and structured investment process called formula investing. Regarding trading execution and strategy, investors can automate their trading strategies and use algorithms for execution.
Due to the ease of access to the internet, sensational news headlines play a role in promoting a feeling of regret in investors. For example, there are numerous online articles from various publishers promoting stocks that offer significant upside and to buy/sell certain stocks. As such, it is imperative to filter out news that may be biased or subjective when considering an investment decision.
Overcoming regret theory involves staying as objective as possible when making investment decisions and to avoid sensational news headlines and emotional biases.
For example:
John primarily invests in the stock market by putting $5,000 at the end of each month into the SPDR S&P 500 Trust ETF. It is currently the middle of the month, and he reads on CNBC that numerous analysts expect a stellar earnings season.
As a result, John feels that it might be a better decision to put $5,000 into the SPDR S&P 500 Trust ETF now rather than wait for the end of the month to avoid the regret of missing a potential stock rally if earnings turn out to be strong.
To overcome regret theory, John should conduct objective research on whether analysts are correct in assuming a stellar earnings season. If he arrives at his own belief that an impressive earnings season is very likely to happen, he can consider investing now rather than later.
If he does not have a strong conviction, he should remain disciplined and continue putting $5,000 at the end of each month into the ETF regardless of the media commentary.
More Resources
Thank you for reading CFI’s guide to Regret Theory. In order to help you become a world-class financial analyst and advance your career to your fullest potential, these additional resources will be very helpful:
FAQs
Summary. Regret theory states that investors will feel regret if a wrong decision is made and will thereby consider this regret when making decisions. Regret theory can alter an investor's risk profile, causing them to be more risk-averse or risk-seeking than normal.
What is Bell's regret theory? ›
Regret theory is a model in theoretical economics simultaneously developed in 1982 by Graham Loomes and Robert Sugden, David E. Bell, and Peter C. Fishburn. Regret theory models choice under uncertainty taking into account the effect of anticipated regret.
What is the regret theory Kahneman? ›
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.
What is the formula for regret? ›
regret = u(possible action) - u(action taken)
Clearly we are interested in cases where the payoff of 'possible action' outperforms the payoff of the 'action taken', so we consider positive regrets and ignore zero and negative regrets.
What are the 4 types of regret? ›
1. Begin by asking whether you are dealing with one of the four core regrets: Foundation regrets, Boldness regrets, Moral regrets, Connection regrets.
What is the fear of regret theory? ›
Regret theory states that people anticipate regret if they make the wrong choice, and they consider this anticipation when making decisions. 1 Fear of regret can play a significant role in dissuading someone from taking action or motivating a person to take action.
What is the maximum regret? ›
Maximum regret is the metric that indicates, if you choose an option, at maximum how much you can regret by not selecting other options. It is also known as opportunity cost.
What is the value of regret? ›
Regret gives us something important if we approach it in the right way: it clarifies what we value and instructs us on how to do better. Regret is conducive to helping us plan our future course by aligning our values with our actions.
What is the least regret basis? ›
The path of least regret urges us to consider the long-term impact of our decisions, even in unfavorable outcomes. This involves evaluating the potential benefits, risks, and trade-offs associated with each alternative.
Is regret a cognitive dissonance? ›
Of course, regret is something of a bite noir for the theory of cognitive dissonance, since it represents the opposite of dissonance reduction through cognitive manipulations. Regret represents a failure to rationalize or justify one's prior behavior.
According to Pink, regrets fall into four categories: Foundation Regrets, Boldness Regrets, Moral Regrets and Connection Regrets. In Chapter 4, Pink states that there is a benefit on reflecting on regrets and that this practice has a benefit that can positively impact future circ*mstances.
What is the regret matrix? ›
The regret matrix is obtained by subtracting each row of the payoff matrix from the maximum value in that column. For example, suppose you have three alternatives (A, B, and C) and two states of nature (S1 and S2) with the following payoff matrix: | | S1 | S2 |
What is the root cause of regret? ›
Regret, like all emotions, has a function for survival. It is our brain's way of telling us to take another look at our choices—a signal that our actions may be leading to negative consequences.
What does God say about regret? ›
2 Corinthians 7:10
“For godly sorrow produces repentance leading to salvation, not to be regretted; but the sorrow of the world produces death.”
How do you beat regret? ›
What to do
- Let yourself feel regret, without avoiding or wallowing in it. ...
- If your behaviour caused harm, try to make amends. ...
- Learn to forgive yourself. ...
- Reframe your experience of regret. ...
- Write about and share your regret. ...
- Use regret to clarify what you value.
Set in the hallucinatory borderland between life and death, The Regrets is a gloriously strange and breathtakingly sexy exploration of love, the cataclysmic power of fantasies, and the painful, exhilarating work of waking up to reality, told with uncommon grace and humor by a visionary artist at the height of her ...
What is the main point of the power of regret? ›
Regrets can improve decisions, boost performance (by increasing persistence), and deepen meaning. The key with regret: use your emotions to understand when you're feeling regret, think about why you're feeling it, and then use it to improve your future.
What is the regret regulation theory? ›
We propose a theory of regret regulation that distinguishes regret from related emotions, specifies the conditions under which regret is felt, the aspects of the decision that are regretted, and the behavioral implications.
What is the regret aversion theory? ›
Regret aversion is a concept within the prospect theory (Kahneman and Tversky, 1979) describing a negative emotional bias that urges investors to avoid regret, thus sometimes making the wrong decision. Tsiros and Mittal (2000) also investigated that regret aversion is a significant negative emotion. Zeelenberg et al.
