Scenario 1
Let’s say you call into a radio station to request your favorite song. When you originally made the call you weren’t aware that the radio station was actually having a contest. If you are the 100th caller in the contest then you win $100. It’s that easy! On this lucky day, you are the 100th caller. You call, receive $100 for you minimal effort and you go on with your day. How sweet is that?
Scenario 2
Let’s say you call into the same radio station to request your favorite song. When you originally made the call you weren’t aware that the radio station was actually having a contest. If you are the 10,000th caller in the contest then you win $10,000. It’s that easy! Now on this day, you are the 999th caller. Since you were so close to the grand prize, you receive a consolation prize of $150. Not bad right?
If I gave you the choice between the two scenarios above, which would you prefer?
If you’re a logical thinker – the ultimate decision would be: do I want $100 or do I want $150?
It seems pretty simple, but it’s not.
In a 1980 paper published in the Journal of Economic Behavior and Organization, Richard Thaler experimented with a similar scenario. Amazingly, a lot of people would actually choose Scenario 1 over Scenario 2. In other words, they would choose to win $100 over winning $150. The reason is “regret aversion.”
The people that preferred Scenario 2 would feel so bad about just missing the grand prize that they would essentially pay $50 to not face that feeling of regret.
What is Regret Aversion?
The idea that most people make decisions in a way to avoid the pain of regret and the responsibility for negative outcomes.
Unfortunately, regret aversion most often leads to inaction.
“For of all sad words of tongue or pen, the saddest are these: “It might have been!” – John Greenleaf Whittier
Think about everything you regret to this point in your life and answer this question truthfully?
What do you regret more?
– Things you did, that you shouldn’t have done
– Things you didn’t do
Most people’s biggest regrets in life center around things they haven’t done – and wished they did. “I should’ve spent more time with this person.” “I should’ve said something sooner.” “I should’ve taken that more seriously.”
People experience more regret over what they did in the short term, while regrets of inaction hurt more in the long term.
Thanks for the psychology lesson, A. Blinkin! Now how does this affect me and my money?
Well to start, it cost you $50 in the original example of this article! More generally – using terms familiar to finance – regret aversion is to blame for cash sitting in a bank account earning nothing when it could be earning higher returns; failing to sell an investment only to see it drop in price; delaying a purchase only to watch the price go up; continuing to pay interest on high-rate credit cards instead of actively searching for cheaper alternatives. Each of these instances would be better by taking action. Instead most of us sit around wondering what could happen instead of using the information we know. We’re so afraid of changing what we’re used to (status quo bias) or taking a chance (regret aversion) to do anything.
“Twenty years from now you will be more disappointed by the things you didn’t do than by the ones you did do.” – Mark Twain
What sort of things do you regret?