When Harry met Edith
Many of you will recognise the French chanteuse Edith Piaf who famously sung, ‘Je ne regrette rein’. Edith’s probably in a minority of one right now. There aren’t many us of who aren’t feeling at least a twinge of regret at the moment – ‘If I only had sold *insert your asset class of choice* when the Coronavirus story broke.’
On the right, we have Harry Markowitz receiving his Nobel Prize in Economics. His work on asset allocation underpins the portfolios of almost every professional investor across the globe.
Markowitz showed us how to create more efficient portfolios by taking account of the risk, return and correlation of assets. What he did with his own pension plan, however, is a lesson for us all about how theory, rationality and smarts can be trumped by emotion.
Markowitz’s pension allowed him choices – he could allocate between equities and bonds. As he later noted to a journalist:
‘I should have computed the historical covariance of the asset classes and drawn an efficient frontier. Instead I visualized my grief if the stock market went way up and I wasn’t in it – or if it went way down and I was completely in it. My intention was to minimize my future regret, so I split my (pension scheme) contributions 50/50 between bonds and equities.’
If the creator of modern portfolio theory is subject to regret impacting his decisions, then it’s fair to say that the rest of us are at risk as well.
Two kinds of regret
Regret is something that we have all experienced. It’s a negative emotion and whilst it feels unpleasant, it has arguably evolved to make us stop and think about our choices. Regret can be separated into two components – experienced (or retrospective) regret and prospective (or anticipated) regret.
We all understand the concept of experienced regret – ‘If only I’d….’
But in the context of derailing decisions it’s the concept of prospective regret, what we’ll feel in the future, that’s important. There’s a lot to know about regret, but I’ve set-out below five important things that you should be aware of right now.
If we are worried about regretting our choices, there can be a tendency to consciously or unconsciously select solutions that we perceive will minimise future regret. Crucially, this may not be the same choice that gives us the best chance of meeting our objectives. For Harry Markowitz, this was a 50/50 portfolio, for each investor it will be different.
Action vs inaction
In most, but not all cases, we feel more potential regret regarding taking actions rather than not taking them. This means that when we are worried about making a choice, there can be a strong tendency to do nothing – it’s a primary driver of the status quo bias. Whilst it can feel more comfortable to wait and see, or to take some action that doesn’t require a decision, e.g. getting more information, in many circumstances, this won’t help create good outcomes.
The doubled-edged sword of feedback
Feedback is an incredibly important tool for learning, improving and good governance. However, there is clear evidence that suggests that when we are made aware that we will receive short-term feedback on the choices that we have foregone, this will heighten feelings of prospective regret.
Whilst regret is a universal emotion (sorry Edith), researchers have shown that some individuals are more prone than others to be impacted by it. Those who are more regret-prone are likely to follow some distinct behaviours, e.g. constantly seeking extra information and analysing options (which may or may not be useful given the decision required).
I think that we’re all perfectly aware that we can find ourselves, or a significant other, carrying over a bad mood from one situation to something totally unrelated (or maybe that’s just my household?) The same holds true for regret. If something has gone wrong recently, it could be that when you come to make a decision about something totally unrelated, you’ll find bleedover effects impacting the new, unrelated, decision.
Solving the problem
When people expect to be confronted with short-term feedback of their foregone choices, regret will loom larger. The vast majority of investors can take a reasonably long-term perspective. Prospective regret can be reduced by focusing on this. For example, if you are re-risking a portfolio, making it clear that the results will be assessed over a 5 year rather than 3 month timeframe is likely to reduce the impact of regret stalling your decision.
Know thyself (and thy colleagues)
Some of us are simply more regret prone than others (in the interests of openness I would put myself in that category). Like lots of things in life, the starting point for improving a situation is accepting it. For example, I know that my innate response when I’m feeling prospective regret is to look for more information. What I’ve learned to do over time is try and figure out if searching for new information will actually help, or if it’s just a coping mechanism. I’ll often involve others in making that call, partly for their perspective, partly to keep myself honest. Being honest with yourself is important. If you’re making decisions with colleagues, help them do the same.
Increase decision quality and justifiability
Research suggests that anticipatory regret might be reduced by attempting to increase the quality of decision through techniques such as applying decision rules. We believe that this can be easily achieved through tools like a ‘CheckLog’.
In the same vein, evidence suggests a key way to reduce the influence of regret is to make choices easily justifiable both within the decision group and to external stakeholders – ‘We should do this because….’ Often this justifiablity can come from your investment adviser. Ensure that they give you a clearly articulated rationale for any decision.
Regret is an emotion that impacts all of us, no matter how smart we are. The evidence suggests that it will play out in very consistent ways, such as the desire to select the regret-minimising choice. If you are an individual, like Harry Markowitz, then ultimately the regret-minimising choice might not be the worst thing in the world. After all, you need to live with your decision for a long time.
For investment boards who manage on behalf of others, I’d argue there is a greater need to look this in the eye, particularly when there is a big gap between the regret-minimising choice and what might give you the best chance of getting to your objectives. However, to be clear, if the regret-minimising choice is better than doing nothing, choose that.
Fortunately, there are ways to dilute the impact of regret. The easiest and most practical thing that you can do is to insist that your professional advisers give you direct, unambiguous and clearly explicable advice that doesn’t focus on the short-term. This will increase perceptions of decision quality, decision justifiability and give you a better chance of making a good choice.
As always, both the science and practice of real-life decision-making is more complex than a blog post allows. If you’re a pension fund trustee or other institutional investor and would like more information, feel free to get in touch.