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Regret Aversion Bias, Part 2.

So we will now review six investor mistakes that can stem from

regret aversion bias.

First, regret aversion can cause investors to be too

conservative in their investment choices.

If I have suffered losses in the past or have felt pain of a very poor decision

regarding a risk investment, I, as an investor, may shy away from making new

bold investment decisions and only accept low-risk positions.

Now this behavior can lead my investment in the long term.

My investment can underperform and that can jeopardize my investment goals.

Secondly, regret aversion can cause me as an investor to

shy away unduly from markets that have recently gone down.

So if I'm a risk averse investor, I may feel that if I invest and

such a market might subsequently continue its downward trend,

this may prompt me to regret the decision to buy in.

However, more often than not, depressed markets offer bargains,

and investors can benefit from

seizing decisively these undervalued investments.

As I mentioned in the other course, trading and

investment, be it in stocks or

in socks, it's about buying good quality merchandise at a bargain.

So if stocks are available at a bargain, that's the right time to invest.

Thirdly, risk aversion can cause investors to

hold onto losing positions for far too long.

If I don't like to admit that I am wrong,

then I could go to great lengths to avoid selling,

i.e., to confront the reality of losing investment,

because when I sell, I realize those losses.

This behavior, which is similar to loss aversion,

is hazardous to my wealth as an investor.

Fourthly, regret aversion can cause herding behavior because,

for some investors,

buying into an apparent mass consensus can limit the potential of future regret.

Needless to say, the demise of the Internet stock bubble and

the demise of the housing bubble that happened from 2003 to 2006

demonstrated that even the most massive herd can stampede in the wrong direction.

Fifth, regret aversion leads investors to prefer

stocks of subjectively designated good companies,

even when an alternate stock has an equal or higher expected returns.

If I'm a regret averse investor,

I may feel that riskier companies require a bolder decision making.

And therefore, if the investment fails, the consequences reflect

more dramatically on my judgment than do

the consequences of investing in a routine or a safe or a reliable stock.

With increased perception of personal responsibility,

of course, comes increased potential for regret.

Investing in good companies may not permit me any more return or

less return than those companies perceived to be risky.

But you know I can always fall back upon the fact that other very savvy investors

have invested and they probably made the same mistake or the market in general

there was some glitch which basically caused the stock price to tank.

Sixth, regret aversion can cause me as an investor

to hold onto winning stocks for far too long.

I may feel that by selling a stock that has been doing well,

I might miss out on further imminent gains.

The danger is that in finance,

as in physics, the law is that whatever goes up must come down.

So now let's try to address each of these pitfalls of regret aversion bias.

And so first, first is essentially investing too conservatively.

No matter how many times I have been burned by an ultimately

unprofitable investment, risk is still a healthy ingredient in any portfolio.

You can't make returns without taking risks.

If I demonstrate that to myself,

the long-term benefits of adding a riskier set to a portfolio, and

if I remind myself that is essential, that kind of helps abrogate this.

Secondly, staying out of the market after loss.

There's no principle that's more fundamental in securities trading than

buy low, sell high.

Nonetheless, you know a lot of investors

behavior completely ignores this directive.

Again, you know, it's human nature to chase returns.

You know, following heart money.

Of course, it's possible to profit from falling trends.

The problem is we never know when the balloon is going to pop and

for example, let's say yesterday's coveted

securities could plummet 40% just in one afternoon.

So disciplined portfolio management is crucial and

critical to long-term investment success.

This means that you buy at times when the market is low and

sell at times when the market is up.

Of course, easier said than done.

Third, holding losing positions for far too long.

There's a very popular adage in the Wall Street which is that the first loss is

the best loss.

Now while realizing losses is never enjoyable, you never enjoy that,

the wisdom here is that following an unprofitable position,

it's best to cut out those losses and move on.

You cut your losses and move on.

Now everyone, each one of us, all investors misstep occasionally.

Even the world's savviest traders do that.

So cut your losses and move on.

Fourth, herding behavior.

Now as an investor I need to remind myself of the outcomes of some other so-called

fly-by-night or flyers that have been taken in the past so

that, at the very least, a speculated decision can be grounded

in a unbiased or historical perspective.

Fifth, preference for good companies.

As an investor, I often think that I can save face, especially with your spouses,

by buying stock in good companies like GE or Coca-Cola.

Now those household names have seen their ups and downs, however,

and they go through ups and downs as much as other competing firms do.

So the idea is that I shouldn't limit myself to good

companies simply because I fear the regret I might experience if an investment

in a lesser known company doesn't work out.

I need to remember that high-profile brands don't necessarily deliver returns.

You know that's not guarantee of returns.

GE and Coke, they're very recognizable, they're very familiar brands.

But that doesn't mean that either company's stock constitutes a sure thing.

Sixth, holding winners for too long.

It's time to entertain one final Wall Street axiom,

which is that you never get hurt taking a profit.

That's not to say that you should not let winners run.

However, if you find numerous objective considerations that

favor selling a security, and if the only reason not to sell is because

I fear regretting a missed opportunity should

the investment appreciate after I sell it, then it's time to take a step back.

I need to remember that I may also experience regret

when a stock begins to decline after I've held it for too long.

So a helpful approach is to attempt to set aside

any emotion that might be impacting the sell decision.

Of course, easier said than done.

And once I feel certain, I need to make a choice and stick to it.

Implementing a plan that we decide a priori and

sticking to it is one of the best ways of averting regret bias.

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19. Regret Aversion Bias 2

Behavioral Investing

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