Regret Minimization
You'd like certainty; you can't have it. Regret minimization is the next best thing.
Last updated
You'd like certainty; you can't have it. Regret minimization is the next best thing.
Last updated
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When considering an important financial decision, it's not uncommon to get caught in "analysis paralysis". Every decision usually has multiple pros and cons, and trying to holistically consider the qualitative and quantitative factors for each side can be a challenge. Individuals can proverbially "lose sight of the forest for the trees".
For major decisions, careful consideration of the key pros and cons is definitely needed. But once you've done that, a mental framework we frequently use with clients (with strong results) is focusing on regret minimization. In simple terms, we ask "If we simplified this down to a Yes/No decision; which outcome would give you more regret?"
It's not a panacea, and decisions in financial planning are rarely binary. But breaking the problem down into a binary outcome and framing it in terms of regret minimization frequently helps point us in the right direction. And, thereafter, energy can be focused on refining the details for the selected (lower regret) path.
Making key decisions regarding stock-based-compensation is one of the primary times we utilize regret minimization with our clients. As noted previously, stock comp tends to follow an 80/20 rule and you can get a long way towards developing a plan by focusing on a few key things. For example, two of the major stock-comp questions we frequently work through with clients are: (1) Should I exercise some/all of my options (or not)? and (2) Should I sell some/all of my stock and/or options (or not)?
In both of these situations, regret minimization frequently helps us get to the root of an individual's thinking, and once we have a general direction we can refine a strategy that works best for them. For example, for the two questions above, the typical question we ask a clients is:
| Key Question/Focus | Regret Minimization Framing |
|---|---|
While stock-based-compensation is the vertical in which we most frequently deploy regret minimization framing for clients, we use it in more than a handful of other financial planning vectors as well. When we use, why we use, and what question we're breaking down into a binary outcome all depends on an individuals specific situation and circumstances. But a few examples are:
| Key Question/Focus | Regret Minimization Framing |
|---|---|
Should I exercise some/all of my options (or not)?
Which of these two outcomes would make you regret more?
(1) You pay <<insert amount>> to exercise your options today, your company ends up failing in a few years and you lose it all
(2) You don't buy any of your options, your company does really well, and when you liquidate your options you'll owe <<insert amount>> more in taxes
Should I sell some/all of my stock and/or options (or not)?
Which of these two outcomes would make you regret more?
(1) You sell 100% of your shares today, and over the next few years the stock price triples
(2) You don't sell any shares today, and over the next few years the stock price declines by more then 90%
Primary home purchase decisioning
Which of these two outcomes would make you regret more?
(1) You buy this home today and unexpectedly need to relocate in 2 years, resulting in you having to sell it for a 15% loss (after transaction fees)
(2) You opt to rent for a couple of years, everything with your employment works out fine, and the housing market increases 10% over the next couple years
Spending more today vs. saving more for the future
Which of these two outcomes would make you regret more?
(1) You spend more today (bigger apartment, more travel), but the reduced savings means you'd need to downsize/relocate if one of you loses your job + you'll both need to work an additional 5-7 years before being able to retire
(2) You forgo some travel and other expenditures to ensure you're on track for retirement. But something happens to one of you 10 years down the line which makes future travel not possible
Taking on too much debt
Which of these two outcomes would make you regret more?
(1) You forgo this mortgage, housing prices and the stock market go up, and you realize that you could have made 2x what you otherwise would have made 3 years from now
(2) You take on this mortgage and other debt. A recession happens; housing prices decline and the stock market is down 30%. And you've lost 60-90% of your current wealth
Not having proper insurance coverage
Which of these two outcomes would make you regret more?
(1) You save $3000 per year by not acquiring long-term-disability insurance. But a few years from now you're diagnosed with a challenging disease. You cant work, income ceases, and all you have are your assets to live on
(2) You pay the $3,000 annual long-term-disability premium (taking a less modest vacation every year to do so). You're part of the 90-plus percent that nothing happens to, and everything is just fine 10 years from now