Regret, comparison and other people

Investors do not evaluate outcomes in isolation — they evaluate them relative to what others achieved and to what they might have achieved.

Regret aversion

The mechanism.

People act to avoid the anticipated feeling of regret, which is distinct from acting to maximise expected outcome.

Regret is stronger for actions than for inactions, which produces a bias towards doing nothing — sometimes helpfully.

And regret is stronger when the alternative was salient and easily imagined, which is why a widely discussed investment that performed well produces more regret than an obscure one.

How it distorts decisions

Specific effects.

Buying into a rising asset to avoid the regret of missing further gains, which is participation near a peak.

Selling after a fall to avoid the regret of further losses, which crystallises them.

Holding a losing position to avoid the regret of realising the loss, which is the disposition effect.

Diversifying away from a plan to avoid the regret of any single holding disappointing.

And choosing a conventional option so that a poor outcome is shared rather than distinctive, which is a documented professional bias and applies to individuals too.

Comparison

Which drives a great deal.

Investment satisfaction depends substantially on relative rather than absolute outcomes, which is why a good return during a period when others did better feels like a loss.

Social media has amplified this by making other people's outcomes visible and by selecting for the successful ones.

Survivorship is extreme: gains are posted and losses are not, which distorts the apparent base rate.

And the comparison is generally against a portfolio you would not have held and could not have identified in advance.

The specific social pressure

Where it operates.

Conversations in which someone describes a successful investment, which produces the sense of having missed something.

Colleagues or friends participating in something you are not.

The feeling during a mania that a sensible portfolio is foolish, which is the pressure that produces the widest participation near a peak.

And, conversely, the reluctance to hold an asset that is unpopular, which is precisely when expected returns are higher.

What helps

Practical measures.

Define success against your own objective rather than against others, which requires having written the objective down.

Benchmark against your plan rather than against the best-performing thing you have heard about.

Reduce exposure to environments where comparison is constant.

Remember that you see other people's wins and not their losses, and that you see the outcome rather than the risk taken.

And recognise that the portfolio you would have needed to own in advance to match a retrospective winner is not identifiable in advance.

The pre-commitment approach

Which addresses regret directly.

Deciding in advance what you will hold and why removes the decision from the moment when regret is operating.

Writing down the reasoning means the future version of you can see that the decision was made deliberately rather than by omission.

And explicitly accepting that you will not participate in every successful thing removes the sense of failure when you do not.

Which is a form of expectation setting, and it is more effective than resolving to feel differently.

The small allocation solution

A practical compromise.

For an investor genuinely troubled by missing out, allocating a small defined proportion to speculative interests contains the damage while relieving the pressure.

The conditions: a fixed proportion, not topped up after losses; separate from the core portfolio; and an amount whose total loss would not matter.

Which is a concession to psychology and is preferable to the alternative, which is abandoning a sensible plan entirely.

The comparison that is useful

Worth substituting.

Compare your position now with your position a year ago, and with your plan.

Compare your contribution rate with what it was.

Compare your costs with what they were.

These are comparisons you control and that reflect decisions you made, which makes them informative in a way that comparison with a stranger's reported outcome is not.

The longer view

Which reduces the pressure.

Over a lifetime, the outcome is determined by contribution rate, costs, allocation and behaviour, none of which are affected by what anyone else did in a given year.

And the people whose reported outcomes produce the most regret are frequently taking risks whose consequences are not yet visible.

Which is not a consolation and is accurate.

General information only, not investment advice. Investments can fall in value and past performance does not indicate future returns. Consult a regulated financial adviser.