AVOID REGRET TO AVOID LOSSES

The state election took place yesterday and the voting queues were lengthy. As I waited to vote, I wondered how people were going to make their decisions. Some are rusted-on supporters of one party or another, others make their decisions on the last sound bite they heard, others will vote the same way as somebody whose opinion they respect, and I’m sure there are some who do a detailed analysis and believe they are making the appropriate decision given the specific objectives they wish to achieve.

In a democracy, no voter can expect to have success all the time. Democratic voters accept that in a democracy there will be times during which they will not be too happy with the party in power. However, as long as their representatives are fulfilling their mandates, most voters will have little regret.

Avoiding regret is a strong component of avoiding bad decisions

‘Regret avoidance’ is a theory used to explain the tendency of investors to refuse to admit that a poor investment decision was made. Human beings generally don’t like regret. They will go to significant lengths to avoid it – they waste time, energy and money in order to avoid feeling regret about a decision.

Regret involving a decision about money is often more costly. Investors will commonly double down on one bad decision in order to avoid regretting another.

Myopic loss aversion (the desire to avoid losses at all costs) and the sunk cost fallacy (the ongoing commitment to an inferior decision) are two common behavioural errors resulting from regret avoidance. Investors often hold onto loss-making investments in the hope that they will at some stage at least break even and after much time and money commitment it’s very difficult for an investor to back off.

There are many ways in which regret is demonstrated

A story on television this week showed an investor with little knowledge, who opened an account to do currency trading. From his perspective, the broker was very pushy and ‘forced’ him to keep investing using greater leverage in order to make up for his losses. With little knowledge and a desire to recover his losses, this investor demonstrated the power of myopic loss aversion and the sunk cost fallacy. His eventual lesson cost him $450,000.

How the housing market plays out in Sydney and Melbourne will be interesting. Expect many late market investors to do everything they can to avoid first, accepting the losses, and second, the loss of face.

There is no perfect way

Just as there is no one way to decide how to vote, there is no perfect way to select an investment. My method of voting is to read the various manifestoes, speak to the candidates whenever I can and then exercise my vote in detail by specifying the exact order of my preferences.

In my early years as an investor, I was less analytical with my decisions and found that I experienced greater regret when losses were made. A number of years ago, I realised that for me to avoid regret, I had to be comfortable with the detail and logic of every decision. I had to know that I had thought of everything that was at least logical. In that way I became more comfortable with the downside

risks so that if and when they occurred, there was no regret and I was able to avoid a further bad decision.

Many investors don’t need the detail. All they need is trusted advisor and the bigger picture principles. Those that are most susceptible to regret are usually those that either have made a rapid decision based on past returns, or don’t fully trust the decision.

A foolproof way to avoid regret is to ensure that the investments chosen are designed to deliver the specific requirements of the investor. Having such a synchronised approach provides a large degree of protection.

Australian voters are fortunate. The difference between the major political parties is very small and, although it sometimes feels like there is major change, in reality each party (certainly over the past 20 years) has on occasions adopted some of the other’s policies. As a result, we can rely on a strong fundamental that the majority of Australians are reasonable people. In the same way, investors can rely on the principles of capitalism, no matter what happens to investment returns in the short term