Humans are wired to feel regret. Here’s how to learn from financial regret to become a better investor.
Topics covered include:
- What cognitive biases make feelings of financial regret unavoidable
- We analyze two regret case studies – one from David and one from a Plus member
- Why do we avoid big regrets but manage through small ones
- Five cognitive tricks to help manage financial regrets
Show Notes
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Investments Mentioned
Vanguard Long-Term Bond ETF (BLV)
Vanguard Extended Duration Trs ETF (EDV)
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Transcript
Welcome to Money for the Rest of Us. This is a personal finance show on money, how it works, how to invest it, and how to live without worrying about it. I’m your host, David Stein. Today is episode 465. It’s titled “Transforming Financial Regrets into Portfolio Gains: Five Strategies for Navigating Investment Emotions.”
An Example of Regret
On Money for the Rest of Us Plus, our premium membership community, we recently had a discussion on our member forums regarding regret. The member wrote that he appreciated the time that we spend on Money for the Rest of Us on figuring out how to better manage our emotions as investors.
This member said that regret he feels is one of his weaknesses. He wrote he regretted following his broker down the dotcom path in the year 2000, suffering a major loss. He regrets not buying a rental property instead of losing that money when the internet bubble blew up. Many of us lost money when the internet bubble blew up.
The regret though that’s particularly bugging this member currently is that back in October, when he saw that 30-year Treasury bonds, the yields exceeded 5% for the first time really since 2007, he sold a lot of bonds in his portfolio and invested in BLV, the Vanguard Long Term Bond ETF. He has made about 16% on that. But what’s bugging him is he also considered buying the Vanguard Extended Duration Treasury ETF, that has a longer duration interest rate sensitivity. It’s returned over 20% in that timeframe, and it’s bugging him. He felt that this opportunity was a fat pitch and that he didn’t swing for a home run in this case.
Humans Are Wired to Feel Regret
We’ll take a closer look at whether that was a fat pitch or not, but this is just one example of regret. And I’ll share some examples of regrets bad that I have had in investing. But in order to better manage regret, we first have to recognize that we are wired as humans to feel regret. It can’t be avoided. There are cognitive biases that we have, that feed our regret.
Loss Aversion
Much of this is work by Daniel Kahneman, Amos Tversky, Richard Thaler, that studied behavioral economics, behavioral finance, decision theory. They really identified many of these biases. Foremost is loss aversion. We feel the pain of losses more than we feel pleasure from the equivalent gain. Losing $100,000 feels way worse than getting or winning or earning $100,000 feels great. A negative review of my book, or the podcast feels way worse, and I remember way more than I do a positive review.
By that token, when we miss out on a gain—so a regret in this case of not investing in something, versus having invested in something and lost money—the feeling of not investing in something and it went up, that actually feels like losing. It can feel worse than the actual gain if we did invest in something, such as the example this member gave. Made 16% on the one investment, but he could have made over 20%. And knowing that, that discomfort feels worse than the pleasure from the 16% gain. So that’s loss aversion.
Hindsight Bias
The other cognitive bias we have is hindsight bias. Feeling like the event, what happened was predictable. That we should have known. That we did know but didn’t act. That’s not true in most cases. It’s really easy to connect the dots going backwards. It makes it seem like “It was all so predictable.” But there are many pathways the future could have taken. It’s just easier to figure out which way it actually came because we’re looking back.
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