INVESTORS, it’s often said, are driven by fear and greed. But I’d add a third item to the list: regret.
The past year and a half have been enough of a rollercoaster to rattle even the most even-keeled investor, creating ample opportunity for regret. Since the fall of 2018, the stock market has dropped 20%, gained 30%, dropped 35% and then gained 30% again. Result? Here are some of the sentiments I’ve been hearing over the past month:
None of these reactions is surprising—but it’s worth asking if regret like this serves a purpose. There are two schools of thought.
Nietzsche famously said, “Remorse would simply mean adding to the first act of stupidity a second.” In other words, don’t waste any time looking back. But the second school of thought sees a lot of value in looking back—because it allows us to reflect on our decisions and ponder what we might do differently next time.
I’m not sure either approach is 100% helpful amid today’s financial upheaval. It’s just too unusual. Still, there’s been a lot of research on the topic of regret. It’s worth understanding some of the tricks that our mind plays on us at times like this. To help manage the stress and make better decisions going forward, keep these key behavioral finance concepts in mind:
Loss aversion. Probably the most famous concept in behavioral finance is something called prospect theory. The research has found that we hate losses, and disproportionately so. In fact, people dislike losses about twice as much as they enjoy gains of a comparable size.
That’s especially important this year. Since the market peaked in mid-February, the S&P 500 is down about 13% through the end of April. But the stock market was slightly higher than it was a year earlier. Still, because of our natural loss aversion, it feels much worse than that. It’s very hard to fight this instinct. The most valuable strategy, in my view, is to maintain perspective. When you consult historical charts, it’s much easier to tune out the hyperbolic headlines and focus on where you really stand.
Rumination. Our minds are prone to rumination, considering and reconsidering what we might have done differently. For the most part, this isn’t productive since the past can’t be changed.
That said, if you’re going to ruminate, I’d recommend translating your thoughts about the past into specific plans for the future. If some aspect of your investment portfolio hasn’t behaved as expected this year, spend time researching that particular investment and consider updating your investment strategy.
Many people, for example, are reexamining their bond portfolio. Others are reconsidering the composition of their stock portfolio, because of the weakness of traditionally “defensive” stocks such as utilities and the surprising strength of seemingly risky technology stocks. To the extent that there’s a silver lining in all this, it’s the opportunity to learn and thus be better prepared for the next big decline.
The breakeven effect. While there should be a difference between gambling and stock market investing, they often trigger similar behavior. That brings us to the breakeven effect.
Researchers have found that gamblers who suffer losses in the morning will often make riskier bets in the afternoon in an effort to recoup the money lost. The same thing has been observed among investors. The solution? Fortunately, unlike a gambler, you don’t need to take any action to make back your losses. As this crisis passes, there’s every reason to expect that the market will recover. It may take some time. But if you believe that the economy will eventually heal, there’s no need to turn up the risk level in your portfolio to break even. It will happen on its own.
The brother-in-law effect. There will always be someone in your life who profited—or claims to have profited—from whatever investment looks the smartest on any given day. These days, that might be Zoom Video Communications or Teladoc Health. But just as you should tune out the headlines, you should tune out your brother-in-law or your know-it-all neighbor. Research suggests you’ll be far better off.
Adam M. Grossman’s previous articles include Defending Yourself, As If and Look Around. Adam is the founder of Mayport Wealth Management, a fixed-fee financial planning firm in Boston. He’s an advocate of evidence-based investing and is on a mission to lower the cost of investment advice for consumers. Follow Adam on Twitter @AdamMGrossman.