Daniel Kahneman’s Solution for Minimizing Investors’ Regrets

Is regret-proof investing possible?

During a conversation at the Morningstar Investment Conference in Chicago, Daniel Kahneman discussed this idea with Sarah Newcomb, senior behavioral scientist at Morningstar.

The Nobel Memorial Prize-winning behavioral economist told the crowd about a period when he was working with a team that did what he described as “sort of planning, financial advising for very wealthy people.”

“The idea that we had was to develop what we called a ‘regret-proof policy,’” he expained. “Even when things go badly, they are not going to rush to change their mind or change and to start over,” he explained.

Kahneman described this idea as “regret minimization.” According to Kahneman, the optimal allocation for someone that is prone to regret and the optimal allocation for somebody that is not prone to regret are “really not the same.”

Kahneman said that this kind of “regret-proof policy” or “regret minimization” idea allows advisors to bring up “things that people may not be thinking of, including the possibility of regret, including the possibility of them wanting to change their mind, which is a bad idea generally.”

In a sense, Kahneman was using loss aversion to create this measure of projected regret.

“We had people try to imagine various scenarios, in general, bad scenarios,” Kahneman explained. “The question was, at what point do you think that you would want to bail out? That you would want to change your mind?”

It turns out, according to Kahneman, that most of the people — even very wealthy people — are extremely loss averse.