Regret Aversion

Regret aversion is the tendency to choose in a way that minimizes the regret one expects to feel after learning how the alternatives would have turned out. Its foundation is regret theory, proposed in 1982 by Graham Loomes and Robert Sugden in the Economic Journal and by David Bell in Operations Research. Bell described the mechanism plainly: after a decision under uncertainty, "a person may discover, on learning the relevant outcomes, that another alternative would have been preferable. This knowledge may impart a sense of loss, or regret." A decision maker "prepared to tradeoff financial return in order to avoid regret" will behave in ways standard expected-utility theory does not predict. The phrase "regret aversion" itself appears in the title of later work, such as Zeelenberg and colleagues' 1996 paper in Organizational Behavior and Human Decision Processes.

Anticipated regret drives the choice; experienced regret is the cost. The bias operates before the outcome is known. People imagine how they will feel if the road not taken turns out better, and pick the option that keeps that imagined feeling small. So regret aversion favors choices whose outcome will never be compared with the alternative, or will be compared with something that makes the choice look defensible, such as what most other people did.

Action and inaction are regretted differently over time. Thomas Gilovich and Victoria Medvec's 1995 review in Psychological Review found that actions "generate more regret in the short term; but inactions, or errors of omission, produce more regret in the long run." That explains a familiar pattern in money decisions. In the moment, doing nothing feels safer, because a loss after an active decision would sting more; years later, the investment never made or the account never opened is the regret people carry. A short-term pull toward inaction and a long-term regret over it can both be true of the same person.

How it differs from its neighbors. Loss aversion is about how outcomes are valued: a loss weighs more than an equal gain. Regret aversion is about a comparison: the outcome is weighed against what the other choice would have produced. Hersh Shefrin and Meir Statman's 1985 paper in the Journal of Finance on the disposition effect, the tendency to sell winners too early and hold losers too long, treated regret aversion as one of several elements in its explanation, alongside mental accounting, self-control and tax considerations: selling a losing position makes the mistake final and invites regret, so the sale is put off. Status quo bias and the default effect draw on regret aversion too, because sticking with what is already in place gives the chooser less to regret.

When it is not a mistake. Regret is a real cost, and paying something to reduce it can be a reasonable choice. The trade-off behind dollar-cost averaging a lump sum is one example: spreading the purchases lowers the chance of regretting a badly timed start, at a price in expected return. The bias is the version that goes unexamined, where fear of a future feeling quietly outweighs a clearly better expected outcome.

The pattern is easiest to see in a decision with a visible alternative. The chooser pictures each outcome, compares it with the outcome of the option not taken, and gives extra weight to the scenarios in which the comparison would hurt. Holding still, following the crowd and keeping the default all reduce the number of comparisons that could hurt, so they are favored even when they are expected to cost money.

An example with invented figures. Talia has $40,000 in cash for a long-term goal and a plan to invest it in a broad stock index fund. She imagines two bad cases: investing now and watching the market fall 20 percent, a paper loss of $8,000 she would blame on her own decision, or waiting while the market rises 20 percent and buying in later at prices $8,000 higher. The first feels worse because it would follow an action, so she waits. If cash earns 4 percent and the fund's long-run expected return is assumed to be 7 percent, each year of waiting gives up about 3 percent of $40,000, or roughly $1,200 of expected return, to avoid one specific regret. Writing a rule in advance, such as investing in four equal parts on fixed dates, would let her trade a smaller, known cost for protection against the regret she fears.

Pros

• Knowing the pattern helps explain decisions that look irrational on paper, such as long delays in investing cash or refusing to sell a loser.
• Regret is a real cost, and a deliberate, priced trade-off against it, such as investing in installments, can be a sound choice.
• Pre-commitment rules turn the bias into a design problem with practical fixes.

Cons

• Unexamined, it trades expected return for emotional comfort, often by defaulting to inaction.
• The short-term fear of acting can produce the long-term regret of having never acted, which the research suggests is the regret people keep.
• Because the bias works through comparisons, following the crowd can feel safe even when the crowd is wrong.