Behavioural Finance – Helping consumers with Regret Avoidance

Behavioural Finance – Helping consumers with Regret Avoidance
Share on LinkedInTweet about this on TwitterShare on FacebookShare on Google+
No matter what we do, there will always be lots of scope, within the context of making investment decisions, to feel regretful about the choices made and the strategies adopted. This is particularly true in today’s economic climate where individuals are taking on ever greater responsibility for managing their own financial affairs. Too often investors fail to admit to themselves when they have made poor investment choices.

Instead, they choose to ignore the issue in order to avoid the unpleasant feelings that arise from facing the outcome of such decisions. Psychologists generally put this tendency of regret avoidance down to what is described as ‘cognitive dissonance’. But what exactly does this mean?

Cognitive dissonance

Cognitive dissonance is often defined as the unpleasant emotions that can arise from holding two contradictory beliefs at the same time. In practice, when cold, hard facts conflict with their beliefs, individuals seek ways to ignore those facts by rationalising them in a way that allows their original, now refuted, ideas to survive.

A classic example of cognitive dissonance is illustrated in Aesop’s fable “The Fox and the Grapes”. In this story the fox spies some grapes high up on a vine and wants to eat them. After numerous failed attempts at trying to reach the grapes the fox decides that he doesn’t want them anymore and that they probably taste sour anyway. In this case, the fox has reduced his cognitive dissonance by criticising the grapes in order to relieve the discomfort it feels at having failed to retrieve them.

Scientists have suggested that whenever we find our values and beliefs being challenged or proven to be misguided, most of us will become stressed and feel ill at ease. The end result of this discomfort is that we will then look to avoid addressing the issues that have confused us or caused such worry and stress.

Consequences

In the context of financial planning and making investment decisions, cognitive dissonance can lead to a situation in which investors become very reluctant to consider any of the relevant issues. This reluctance could potentially lead to investors holding onto losing positions too long, in the hope that they will eventually make their money back. In this way investors do not have to face the regret of realising the loss. Regret avoidance can also cause investors to sell winning positions too early in an attempt to lock in profits before they can turn into losses.

When it comes to investing for the future, the potential for a sense of regret is huge and it can be a real problem and a deterrent to action for people when the stakes are high and the most pertinent issues are not easy to identify.

By not wanting to make decisions they might later regret, some people may instead prefer to leave the whole business of financial planning and investing for the future to chance. Part of the problem is that it can be difficult for people to accept that even with their best efforts at analysis, unforeseen circumstances and scenarios can arise.

Inevitably, in some cases, an investor’s chosen investments may not generate the amount of income that was hoped for or intended. However, there is a considerably improved chance of an investor’s portfolio or funds delivering better returns if they are aware of the existence of regret avoidance and the appropriate action they can take in order to mitigate it or, indeed, avoid it altogether.


Ben Cicchetti, EValue's Marketing Manager

Ben, an Associate of the Chartered Institute of Marketing, has worked in the financial services and technology industries for over 10 years. He is passionate about injecting creativity throughout our marketing and communicating how our solutions can truly make a difference to people’s financial futures.

Share on LinkedInTweet about this on TwitterShare on FacebookShare on Google+

Related Content