Risk is an unavoidable part of business, regardless of whether you’re a startup founder or operate a successful established business. As an owner, it’s likely your job involves making risky investment decisions. To invest or not invest? That’s what it boils down to.
Business is mostly conducted with the mind, rather than the heart, but have you heard of the feeling that drives people to forego investment opportunities?
What is ‘regret avoidance’?
‘Regret avoidance’ is an economic theory based on the idea of this feeling. The word ‘regret’ immediately conjures past business decisions that ended up costing you.
The theory is that people will often try to avoid making decisions because they fear the consequences of – and the regret associated with – making a decision that might turn out to be wrong. In other words, this fear of future regret influences a person’s judgment about making a decision in the present.
Risk tolerance is defined as a person’s willingness to take risk. The higher the risk a person is willing to take, the higher their risk tolerance is. Bailey and Kinerson conducted a study on this topic. The study involved giving the participants hypothetical information on a) shares in which they previously invested that had resulted in a loss and b) a savings account which also caused loss. The study produced the following results:
- A person’s risk tolerance is a very strong predictor of their choice behaviour when put in an investment situation.
- People that experienced regret in a particular type of investment situation are less likely to invest in the same manner in a similar future investment situation.
- Regret creates a psychological bias which can hinder a person’s rational thinking when making decisions.
How is it affecting your business decisions?
The above study might reveal a few things about how you make business decisions.
If you like taking high risks, then you are likely to be more positive in accepting a risky business decision.
However, if you’ve had a negative experience (e.g. an investment or a business decision cost you money or resources), you are less likely to make a similar decision in the future – you will be biased to the potential benefits of a new investment or business decision. Consequenetly, you are likely to ‘sit still’ when it comes to potential investments because deviating from the norm could expose you to risk of loss.
For example, let’s say you invested in shares in Company X but then decided to switch to shares in Company Y. Later that year you find out that you would have received $1000 if you kept your shares in Company X. This decision is likely to impact your future decisions about making investments, even though shares are fairly unpredictable. In the future it may actually be advisable for you to invest in Company Y. However, by anticipating regret and hesitating, you could potentially miss out on an opportunity to make money.
What should I do?
Taking risks is the essence of business. You may fail or you may taste the sweet success. It takes more than luck to run a business but basing your decisions entirely on past experiences could make you inflexible in adapting to new situations. Similarly, deviating from a set behaviour could cost you. Do your market research and listen to your advisors.
About the author
Ananya Singh is Legal Analyst at LawPath, a provider of cloud legal services for small to medium businesses.