Behavioral finance studies have shed new light on how investors make decisions. Study results from 2013, recently shared by Fidelity Investments, have illustrated the concept of regret as it relates to decision making. Investors experience "action regret" when making a poor investment decision. In contrast, they experience "inaction regret" when choosing to do nothing when given an opportunity to make an investment that proves to be successful.
Research has shown that, of the investors in a study who made bad investment decisions, 92% regretted that decision and suffered feelings of action regret. However only 8% who had the opportunity to choose an investment opportunity that did well, but chose not to invest, suffered inaction regret. Researchers concluded that investors are much more afraid of making a bad investment decision than they are of doing nothing and missing an opportunity.
Researchers also found that these initial, stronger feelings of action regret tend to fade over time. When older investors were asked about those decisions they regretted most, 25% responded that they regretted the bad decisions they made. Conversely, 75% indicated they regretted not taking action when faced with an opportunity. Study results showed that while the initial feelings of action regret were stronger, they also faded quicker. In contrast, feelings of inaction regret that were initially low, grew over time.
The fear of making a bad decision leads participants to invest more conservatively than they should. As a result, they elect allocations in their 401(k) plan accounts that favor fixed income investments over stocks. Consequently, they never accumulate a balance that is great enough to meet their retirement goals.
Overcoming participant regret
Many participants, once they become aware of study results, are able to relate to their feelings surrounding regret. However, since they are not professional investors with deep educational backgrounds in economics and finance, they are unsure how to change the way they invest. As a result, professionally managed investment options tend to work best for them. These would include target date funds and managed portfolios.
Most experts believe that 75% of all 401(k) plan participants belong in professionally managed options (normally target date funds). Make sure that your employee education sessions stress the importance to participants of evaluating the target date fund options in your plan.
Robert C. Lawton is president of Lawton Retirement Plan Consultants, LLC a Registered Investment Advisory firm helping retirement plan sponsors with their investment, fiduciary, employee education and compliance responsibilities. He may be contacted at firstname.lastname@example.org or 414.828.4015.
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