Behavioral finance studies have shed new light on investor decision-making. Recent study results shared by Fidelity Research, 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.
Differences between action and inaction regret
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 bad decision-making. 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 impact of regret on participants
The fear of bad decision-making leads participants to invest more conservatively than they should. As a result, they elect allocations in their 401k 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 decision-making regret in 401k plans
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 401k 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, AIF, CRPS is the founder and President of Lawton Retirement Plan Consultants, LLC. Mr. Lawton has over 30 years of retirement plan consulting and administration experience and has provided consulting services to many Fortune 500 companies including: Aon Hewitt, Apple Inc., AT&T, First Interstate Bank, Florida Power & Light, General Dynamics, Houghton Mifflin Harcourt, IBM, John Deere, Mazda Motor Car Company, Northwestern Mutual, Northern Trust Company, Trek Bikes, Tribune Company, Underwriters Labs and many others. Mr. Lawton may be contacted at (414) 828-4015 or email@example.com.
Lawton Retirement Plan Consultants, LLC is a Milwaukee, Wisconsin-based independent, objective Registered Investment Advisory (RIA) firm providing investment advisory, fiduciary compliance, employee education, vendor management and plan design services to 401(k) plan sponsors. The firm currently has contracts in place to provide consulting services on more than $400 million in plan assets. For more information, please contact Robert C. Lawton at (414) 828-4015 or firstname.lastname@example.org or visit the firm’s website at: http://www.lawtonrpc.com. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser.
This information was developed as a general guide to educate plan sponsors and is not intended as authoritative guidance, tax, legal or investment advice. Each plan has unique requirements and you should consult your attorney or tax adviser for guidance on your specific situation. In no way does Lawton Retirement Plan Consultants, LLC assure that, by using the information provided, plan sponsor will be in compliance with ERISA regulations. Investors should carefully consider investment objectives, risks, charges and expenses. The statements in this publication are the opinions and beliefs of the commentator expressed when the commentary was made and are not intended to represent that person’s opinions and beliefs at any other time. The commentary does not necessarily reflect the opinion of Lawton Retirement Plan Consultants, LLC and should not be construed as recommendations or investment advice. Lawton Retirement Plan Consultants, LLC offers no tax, legal or accounting advice and any advice contained herein is not specific to any individual, entity or retirement plan, but rather general in nature and, therefore, should not be relied upon for specific investment situations. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser and accepts clients outside of Wisconsin based upon applicable state registration regulations and the “de minimus” exception.