The Anatomy of Regret

How Investors Cope with Past Mistakes

Regret, a universal emotion spanning finance, investing, and life, fuels ruminations, sadness, and frustration, yet also drives personal growth through the lessons it imparts.

In this week’s edition, we will explore how people react to regrets and their own mistakes, delve into the psychological and medical aspects of regrets, and examine historical examples where dwelling on regrets has negatively impacted financial decisions. Additionally, we will touch upon a few fascinating non-finance-related historical examples where cognitive biases influenced decisions in remarkable ways.

In the world of psychology, regret has been a subject of extensive research. Neuroscientific studies have shown that the brain processes regret in the anterior cingulate cortex and orbitofrontal cortex, regions associated with decision-making and emotional processing. Hormonally, regret can trigger the release of stress-related hormones like cortisol, contributing to emotional distress. The amygdala, a part of the brain linked to emotions, plays a crucial role in modulating these hormonal responses that could affect people’s decisions.

One of the most common psychological consequences of regret in financial decision-making is the 'Hindsight Bias,' where individuals tend to perceive events as predictable or expected after they have already occurred, often leading to a sense of regret for not foreseeing them.

During the lead-up to the 2008 financial crisis, many investors regretted not having sold their stocks earlier. Hindsight bias led them to believe they should have seen the crash coming, which affected their subsequent investment decisions.

In the late 1990s dot-com bubble, some investors regretted not investing in technology stocks earlier. This regret influenced their decisions, leading to overinvestment and, ultimately, substantial losses.

Amid the collapse of the U.S. housing market in 2007-2008, individuals who had bought homes at the peak of the market experienced profound regret. Some held onto their properties, hoping for a rebound, while others sold at substantial losses.

Speaking of holding onto things and not letting go, another known phenomenon in the field of psychology and behavioral economics related to regret is something called the “sunk cost fallacy”.

The sunk cost fallacy refers to a cognitive bias in decision-making where individuals persist with an investment solely because they have already expended significant resources (time or money or both), even when continuing offers little prospect of success or added benefit. It's like staying in a bad movie just because you paid for the ticket. In simpler terms, it's throwing good money after bad, a bit like trying to teach a goldfish to play the piano – it's not going to work, no matter how many piano lessons you've already given it.

Now, as usual, let's take a stroll down memory lane, shall we?

In the Vietnam War, the U.S. government continued to invest in troops and resources despite mounting evidence that the conflict was unwinnable. This is an example of the sunk cost fallacy, where past investments drive irrational future decisions.

Or the case of the Boeing 737 MAX: After two tragic crashes in 2018 and 2019 that were linked to design flaws in the aircraft, Boeing faced mounting concerns about the safety of the plane. Despite these issues, Boeing initially resisted grounding the aircraft, citing the substantial investment and time already poured into its development.

This decision not only had profound safety implications but also severe financial consequences for Boeing. The company's stock price plummeted, and it faced significant regulatory scrutiny and reputational damage. Ultimately, Boeing's insistence on continuing to fly the 737 MAX, driven in part by the reluctance to acknowledge the sunk costs, led to a substantial financial crisis and a reevaluation of their decision-making processes.

The moral of these stories, you ask?

Not everything happens for a reason. Sometimes life won’t make sense. At times, it has a rather stale sense of humor. And we might never be able to understand why certain things happened to us. The point is we could never predict what life will throw at us. Every day we wake up, we gamble our destiny with the smallest decisions that are before us, and we have to make. And it is only normal when some of these decisions lead to dark paths.

In the theater of life's decisions, regret and the sunk cost fallacy put on quite a show. Regret, the eternal optimist, regrets not taking the road less traveled, while the sunk cost fallacy insists on finishing a bad book just because you're halfway through.

Note of the month: We are products of our past, but we don’t have to be prisoners of it. Winners in life never learned how to walk by following the rules; they learned by doing and by falling off the cliff.

Beyond The Numbers is a monthly newsletter that aims to delve into the human side of finance, exploring emotions, psychology, and biases that influence our financial decisions. My name is Sadaf Poursheikhani, and I am a behavioral economist, passionate about dissecting investor psychology. Join me as we uncover the hidden secrets of the financial world.

Disclaimer: I would like to remind readers that this newsletter is based on scientific studies, my own research, and personal opinions. It does not reflect the views of any organization, and I am not providing financial advice. Rather, the aim is to shed light on the emotional side of the market and provide insights into how emotions can impact financial decision-making.