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How does the emotion of regret play into our investing decisions?

Past experiences and emotions both influence current decision making. Dr. Meir Statman shares what we need to know about what a powerful driver regret can be when it comes to our financial choices.

Transcript

Tim Maurer:
Hello and thank you for tuning in to Ask Buckingham, an ongoing video podcast series where we invite thought leaders across many disciplines in wealth management to respond to your timely questions with timeless answers.

Tim Maurer:
My name is Tim Maurer. I have the privilege of hosting these short discussions as the director of advisor development for Buckingham Wealth Partners. I want you to know that I’m also a wealth advisor myself with more than 20 years of experience and a client of the firm. The volume of information coming at us these days is so vast, and the pace at which that information arrives is so fast, and it’s a struggle to keep up with what you need to know in order to make the best decisions for you and your family.

Tim Maurer:
Our hope, therefore, is that this ongoing conversation will become a source of clarity in the midst of confusion and provide insight that helps you better understand what’s going on in the world financially and otherwise. Today we’ll be hearing from Dr. Meir Statman, a consultant to Buckingham and the Glenn Klimek Professor of Finance at Santa Clara University and, by the way, one of the world’s foremost authorities in the field of behavioral finance. Here’s the question we’ll be tackling. Dr. Statman, how does the emotion of regret play into our investing decisions?

Dr. Meir Statman:
Well, regret is a very painful emotion and actually a very common emotion. It is the most frequent emotion that we feel. We describe regret as a cognitive emotion that is unlike fear where you slam the brake. Regret is something that you think about. And so, you think about how would you feel if, for example, you invest in stocks and they go down, or sell your stocks and they go up? Of course, on the other side of regret is pride. Now, just as with loss aversion, the pain of regret is greater than the pleasure of pride. And so, that is an emotion, again, that is very useful. Think about it. When you are a toddler, when you are in kindergarten, if you hit the child and then you get punished for it or that child is no longer your friend, you’ve learned the lesson. Don’t do that. Similarly, in all other walks of life that is regret teaches you to think about what you have done, to think about the consequences and from that to learn.

Dr. Meir Statman:
If you study for an exam and you get an A, the lesson is, “I take pride now and I know how to do that. I’ll study for the exams, I’ll get an A, I will move up in life.” Again, like all emotions, regret can be exaggerated. And so, there are issues of cognition that come with regret and pride. One has to do with hindsight. The other has to do with responsibility. That is, think about the market today and think about it a month or two ago. Now, you look at it and you say, “God, wasn’t it clear that the market is going to go down?” Well, it wasn’t clear to me and it is likely not clear to you-

Tim Maurer:
Indeed.

Dr. Meir Statman:
… and to anybody else. It is just that, in hindsight, everything is 20/20.

Tim Maurer:
Sure.

Dr. Meir Statman:
And so, we think that we have seen it and then we feel regret for not having taken the right action. Why didn’t I get out of the market two month ago? Responsibility is really very crucial here because, if something bad happens but you’re not responsible for it, it’s kind of an act of God, then it feels sad. But you don’t feel regret because you did not really make any decisions. But when you feel responsibility for that choice, when you, for example, thought about getting out and then said, “No, I’m not going to get out,” and now the market has gone down and you feel responsible, that brings that emotion of regret. And so, this comes back to issues of habits and procedures and sequence of events. If you have the habit, the rule, that says, “The market goes up, the market goes down, I do nothing,” then you in fact remove responsibility and you’re going to feel better about it than if you always think about, “Should I do this, should I get out of the market, should get in?” You are going to assume responsibility and you’re likely to experience regret.

Tim Maurer:
It seems as though through this reframing of those emotions or by creating habits, as you said, to respond to them, it seems almost like we can train our emotions. Is that true? We can change what our emotional response to the stimuli would be over time?

Dr. Meir Statman:
Well, you cannot change the emotion of fear, for example. That is, if somebody looks like he’s gone to throw sand in your eyes, you’re going to close your eyes. This is an instinct and you cannot change it. But what you can do is keep distance from your emotions. My mother said, and your mother said, “When you are angry, count to 10 before you open your mouth.” That is very good advice and illustrates this distancing from your emotions because you know in a moment of calm that words said in anger cannot be retrieved, and they can have very difficult, very bad consequences for you. If you say to your boss, “I quit,” and then you say, “Oh no, I changed my mind,” well, your days at their job are likely numbered. And so, you can train your emotions by being able to stop before you act, especially when the consequences of the wrong action are going to be very bad. In this sense, you should let your reason, your logic, to interact with your emotion and restrain it or amplify it as necessary.

Tim Maurer:
Excellent. So how do you think we could apply this knowledge? In a situation like the one we’re seeing, with crazy market drops and occasional ups on different days, how can we train ourselves, train our emotions, or train our responses to those emotions to have the best outcome?

Dr. Meir Statman:
Well, again, you have to use the tools of science. The tools of logic, the tools of evidence. And so, what you should know is that it is natural for you to feel fear. It is natural for you to feel regret, but you should ask yourself, is that fear justified? Probably, but don’t let fear turn into panic. I’ve a rule that says, I’m not going to act when I’m fearful or when I am exuberant and definitely not give in to panic. And so, by telling yourself, knowing that markets will go up and markets will go down, that we have the tendency to extrapolate from the recent past, that extrapolation is common, it is natural, but it is wrong. You will be able to stop yourself from making decisions that are unwise.

Tim Maurer:
Very helpful. Dr. Statman, lastly, we’re teaching people how best to respond to the current crisis of the moment. But what would you say to the investor who in the past may have made a poor decision, may be in the 2008 crisis or the 2000, 2001, 2002 crisis, and they still are regretting a poor investment decision they made about that past? What would you have to say to them?

Dr. Meir Statman:
Well, I would have to say that just because you made the mistake in the past does not mean that you should repeat it. If you have taken action that by luck turned out to be good, remember that luck plays a role on the good and the bad. In fact, I have a friend who, because of his employment situation, sold his stocks at the end of 2007 and then watched the market go down and felt very smart.

Dr. Meir Statman:
But then as the market started to go up, he thought that that is just a fluke and the market will continue to go down. As it went up, he found it really hard to get back in because of that regret and because of the feeling of, “I’ll be stupid to actually buy stocks at the price higher than the price that I sold them.” And so, this is a very good experience and he’s kind of learning from that.

Dr. Meir Statman:
And so, he’s getting back in by dollar cost averaging. The market, of course, now is down, but the lesson is still an important lesson because when you act in panic and, say, sell all your stocks, you will then have to make another decision of when to buy. That is going to be really difficult because your emotions will get in, your pride will get in and you are going to end up making two bad decisions.

Tim Maurer:
Indeed. So staying in a well-constructed portfolio is one decision. Attempting to get out is two, because you not only need to decide when to get out, you need to decide to get back in. Sound advice. Thank you, Dr. Statman and thanks to you for tuning in to this episode of Ask Buckingham. If you have a question that you’d like to see us address, you can do so by navigating to the website, askbuckingham.com, or emailing your question to question@askbuckingham.com. Or just click in the upper right-hand corner of the screen. It’ll take you directly to the website. Remember, there are no dumb questions, but unfortunately, there are plenty of poor answers out there. Our hope is that, in giving you straight answers to your questions, you’ll be able to apply that knowledge in pursuit of good decision-making. So please, follow us. And by all means, ask Buckingham.

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