These seem very similar to me. Anyone have a concise way to distinguish them from one another?
Loss aversion is when you’re averse to taking losses. What generally happens in this situation is investors will tend to hang on to their losing stocks for too long. In addition, some fund managers will actually seek risky investments because they do not want to report any losses at the end of the period. Regret minimization is when an investor does not want to take an action that may result in regret. A prime example of this is an investor who will not invest in say equities because he doesn’t want to experience regret should the investments drop in value. As a result, Regret Minimization tends to lead to undiversified portfolios. Hope this helps…
Yeah, that helps. They both imply that investors want to avoid losses (who doesn’t?). Loss Aversion is maybe more applicable to someone who has an investment they should sell and don’t because they don’t want to book a loss. Regret Minimization is maybe more applicable to an investor that wants to avoid investing in something that could potentially lose. Sound right?
Also, Loss Aversion = Reference Point as they call it on older exams.
With loss aversion, the investor may also take on riskier positions to try and make up for losses.
Sound OK to me. I always thought the way you wrote, Loss aversion – you own the stock and you dont want to see the loss Regret mini — you still do not have it and you want to avoid the loss
bigwilly, How do they use “reference point” in the questions? I haven’t yet gone over the CFAI exams but curious to see what the impact of that terminology is on the question at hand. Thanks.
say you bought the stock at $100, the $100 becomes your reference point in the context of loss aversion, since you don’t want to end up with less than you paid for it
Got it… thanks.
And it seems like a key point for both is that they lead to risky behavior either by not selling when you should (incurring even more losses) or by not investing in something at all (not having a diversified portfolio).
PJ CFAI 2004 Exam.