Regret Aversion Bias: When Fear of Being Wrong Keeps You From Being Right

The opening quote of this chapter is from Harry Markowitz, the father of Modern Portfolio Theory. He said he split his retirement contributions 50/50 between bonds and equities because he wanted to “minimize my future regret.” Not maximize returns. Not optimize the efficient frontier. Minimize regret.

If the guy who literally invented modern portfolio theory makes decisions based on regret avoidance, what chance do the rest of us have?

Two Types of Mistakes

Pompian introduces an important distinction in this chapter: errors of commission versus errors of omission.

An error of commission is when you do something and it turns out badly. You bought the stock and it crashed.

An error of omission is when you fail to do something and miss out. You did not buy the stock and it tripled.

Here’s the thing: research shows that errors of commission hurt more than errors of omission. Losing money on a stock you actually bought feels much worse than missing a gain on a stock you never purchased. Why? Because with commission errors, you feel personally responsible. You made a choice and it was wrong. With omission errors, you can tell yourself “well, I just did not get around to it.”

This asymmetry has huge implications for investing behavior.

The Schmoogle Example

Pompian uses a fictional company called “Schmoogle” (clearly inspired by Google) to illustrate the dynamics.

Jim has a chance to buy Schmoogle stock after it dipped 10%. He thinks it has potential. Two possible scenarios:

If Jim buys and the stock drops further: Jim committed an error of commission. He feels strong regret. He actually did something, spent money, and lost it. The pain is intense.

If Jim does not buy and the stock rebounds: Jim committed an error of omission. He missed out on gains. He feels some regret, but it is not as sharp. He did not actually lose money. He just did not make money.

Because the pain of commission errors is so much stronger, regret-averse investors tend to default to inaction. They do not buy because the pain of buying and losing is worse than the pain of not buying and missing out.

The Six Ways Regret Aversion Hurts You

This chapter identifies more specific problems than most of the other bias chapters. Pompian lists six investor mistakes linked to regret aversion:

1. Investing too conservatively. After getting burned once or twice, regret-averse investors retreat into ultra-safe positions. They swear off stocks entirely. They load up on bonds and cash. Sure, they will not experience big losses. But they also will not experience the growth they need to meet their long-term goals. Being too conservative is not “safe.” It just trades one risk (volatility) for another (not having enough money at retirement).

2. Staying out of the market after a dip. When markets crash, logic says to buy. Prices are low. Bargains are everywhere. But regret-averse investors think: “What if I buy and it drops more? I will feel terrible.” So they sit on the sidelines and watch as the market recovers without them.

3. Holding losers too long. This overlaps with loss aversion, but the mechanism is slightly different. Loss-averse investors hold losers because they do not want to realize the loss. Regret-averse investors hold losers because selling would mean admitting they made a bad decision. They do not want to feel the regret of having been wrong.

4. Herding behavior. This is a fascinating one. Regret-averse investors follow the crowd because if everyone is doing it and it goes wrong, at least they were not alone. If the entire market crashes, you can say “nobody saw that coming.” But if you made a contrarian bet and it went wrong, that is all on you. So regret aversion pushes people toward consensus, even when the consensus is wrong. Remember the tech bubble of the late 1990s? That was a massive herd stampeding in the wrong direction.

5. Preference for “good companies.” Regret-averse investors gravitate toward big, well-known companies even when smaller ones offer equal or better expected returns. Why? Because if you invest in General Electric and it tanks, you can say “GE fooled everyone.” But if you invest in some small company nobody has heard of and it tanks, you feel uniquely stupid. The regret is worse because the responsibility feels more personal.

6. Holding winners too long. You have a stock that has been doing great. Every objective indicator says it is time to sell. But you think: “What if I sell and it keeps going up? I will regret selling.” So you hold. And sometimes the stock does come back down, and now you regret not selling when you had the chance.

Dividends and Regret

Pompian discusses a study by Shefrin and Statman that connects regret aversion to the preference for dividend-paying stocks. The logic goes like this:

If you own a stock that does not pay dividends, you need to sell shares to get cash. If the stock goes up after you sell, you have committed an error of commission. You actively sold something that would have made you more money. Painful.

But if you own a dividend-paying stock, the cash comes to you automatically. If you want more cash, you just spend the dividend. You never have to make the active decision to sell. And if the stock goes up? Well, you did not sell any shares. You just spent the dividend. The error, if there is one, is an error of omission (not reinvesting the dividend), which hurts less.

So the preference for dividends is partly driven by regret aversion. People want cash flow that does not require them to make decisions they might regret.

What To Do About It

Understand that risk is necessary. No matter how many times you have been burned, a properly diversified portfolio needs some risk. Look at the long-term data on efficient frontiers. Adding risky assets to a conservative portfolio actually improves the risk/return profile. Being too conservative is not playing it safe. It is actively choosing worse outcomes.

Buy low, sell high. Really. This is the most fundamental principle in investing, and regret aversion causes people to do the exact opposite. They avoid buying when prices are low (fear of further drops) and avoid selling when prices are high (fear of missing more gains). Discipline means doing what the data supports, not what your emotions want.

Cut losses early. There is a Wall Street saying: “The first loss is the best loss.” Selling a loser is not admitting failure. It is being smart. Even the best hedge funds take losses all the time. The difference is that they do it quickly and move on.

Question herd behavior. Before following the crowd, ask yourself: does this trade relate to any of my long-term financial goals? If you cannot connect it to a specific goal, you might just be following the herd out of fear of missing out or fear of being the odd one out.

Do not limit yourself to famous brands. Big Company and Small Company might have identical risk and return profiles. Choosing Big Company just because it is well-known is not a financial decision. It is a regret management strategy. And it can cost you returns.

Have a system for selling. “You never get hurt taking a profit.” If your objective analysis says sell, sell. You can always buy back later. But do not hold on just because you are afraid the stock will go up after you sell. It might. But it also might go down. Make decisions based on data, not on fear of future regret.

My Take

Regret aversion is maybe the most human of all the biases we have covered. We all know that feeling of kicking ourselves for a bad decision. And we will go to great lengths to avoid putting ourselves in a position where we might feel it again.

But here is what I noticed about regret: you feel it no matter what you do. If you buy and it drops, regret. If you do not buy and it goes up, regret. If you sell too early, regret. If you sell too late, regret. There is no decision path that eliminates regret entirely.

So the question is not “how do I avoid regret?” The question is “how do I make good decisions despite knowing I might regret them?” And the answer is: have a plan, follow the data, and accept that some regret is just part of being an investor.

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This is part of a series retelling “Behavioral Finance and Wealth Management” by Michael M. Pompian. Start from the beginning.