Behavioural Finance: Regret Aversion Bias

Have you ever felt that a company is doing good business and wanted to buy the stock, but waited for a drop in price. And the stock never came down, you never invested and gave manifold returns only on paper. Didn’t you want to kick yourself because you failed to grab the opportunity? Why did you do it?

You know you did your analysis and found a good stock. But you were doubtful if you made the decision and the stock instead went down – you would regret having got in such a high price and sitting at a loss. The fear of regret made you not make any decision and making you miss it.

Some times we would have got in a stock at a very low price and would sit on nice profits. You would now get anxious whenever it closes red even for a day. You then decide to get out of the stock taking how many ever profits you got. After you are out of the stock, it continues to go up and give more than double the money you would have invested.

All these are called the “Regret Aversion Bias”.

Examples from my life

I have examples in my own investing life for both the types. I wanted to buy MRF which was trading at Rs.10000. I felt that it was too high and wanted to wait for a few days for it to correct a bit. It didn’t and in over a year it more than doubled the investment. A good stock, but because of my fear of regret, missed the opportunity.

Another example when I invested in Idea Cellular. The markets tanked in 2008 after I bought and I held it for more than a year or two. It reached my cost price and even gave me 10% returns. As I was very new to investing and already burnt by the bear market wanted to get out of it with at least the 10% profit. I did get out, but now I hate myself for missing the opportunity to hold the stock and get more than double the returns.

How to avoid this bias?

Before you make an investment decision spent enough time and resources to analyse the company. Its OK even if it takes an extra day or two. If it is a good company with good fundamentals, a few rupees of difference in your cost price wouldn’t matter much. Once you are sure that it is a good company and decided to invest, don’t wait forever to invest. Get in the stock and stay invested. If it corrects, you can average it, provided it is still fundamentally good.

Second important factor to remember is to not get out of the stock just because it gave your 10% or 20% returns. Try to ride the wave and see how long till it tops out. You will be more profitable waiting for a stock to top than get out every 20%.  Understand your risk taking ability and also make sure that your risk-reward ratio is favourable.

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