A review of Predictably Irrational and what we can learn for investing.
I have read this book before and again a month ago. As probably now more than ever we are living in a consumer lifestyle, I have written an article. About the minimalistic lifestyle (Link below)
- Some of the key points to take from this book are your anchor on to what you are using in terms of price. For example, you wouldn’t buy a loaf of bread for $10 as you are used to having it for much less. But how do we know what things are worth what they sell for?
A more fitting example to answer this would be if you were buying a watch. They all have the same basic function so how do you know how much to pay.
I have had friends buy a Rolex, for $7000, but how do you know it is worth this amount. The answer is that they have seen similar watches for that price or more they are anchoring the price to a set amount.
So if we saw the same Rolex (or other high-end watches) at $2000 we would jump to get it thinking we are getting a could deal.
This was allocated in the book by bread-making company that had its machines going for $99 that no one bought due to the fact that they didn’t know how much bread making machines were worth. So what did they do to increase sales? They made a higher-end bread making machine that sold $199 automatically the lower one increased its sales significantly. As people thought they were getting a better buy the lower end bread maker.
I have done this with houses, you see a house for sale and rent in Hong Kong and think I should get this as its great value, and seen a similar size condo, in Bangkok (3 times less) and think they are overvalued (I do have a system when looking at buying houses) but the point, is your mind automatically anchors to a comparison price.
So what should you do, try not to think of it like this, I was taught when you buy something, always think how many hours you will have to work to pay it off. For example, when I get a bottle of wine, I think that is 10 minutes work, is it worth it? Not, it’s going for $20 instead of $30, I need to get it because it’s going cheap at the minute. That’s called marketing.
From an investing standpoint, go back to Benjamin Graham, The Intelligent Investor and not look at the cheapest stock but look at the value of it and the business credentials, this is what Warren Buffet has applied to his investing and his philosophy. It’s worked out okay for him.
- People love the word “Free”. The word “free” is associated with risk-free, this means that you can’t lose. So if you get something free you don’t have to risk anything. Why did Amazon, shipping do so well as they offered “Free” shipping? Although, the price is mainly implemented within the cost but people are more entitled to buy it as it is free and believe no risk associated with it.
An example of this is how many times have you bought a happy meal from Mcdonalds because of the free toy for a child? Or how many times did you got to Mcdonalds to get a free cheeseburger with the meal as well? Shops and many other places will offer something as free in order to make it look like they are giving you more value, but actually you are buying something that you don’t really need! So why do people act like this? It comes down to loss aversion, this is where people are scared of loss. You have to pay and exchange money for something and the risk is that you might not like it and therefore will lose that money that you have just spent. But with free you have nothing to lose, so you might as well get it.
For this in the context of investing, many people prefer capital protected or structured products although they are much riskier (if you knew how they worked) and are more expensive in fees. Don’t go with something just because it is free, look deeper into what it really is, understand how it works, how it is structured and what makes it a good investment.
Okay, this last one doesn’t really fit into investing but it is about social norms. Social norms are different from market norms, imagine a friend asks you to help out with moving house and you were free, you would help them. But, what if your friends asked you again and said they would pay you $2 an hour, you would say no, that’s not worth your time. This is because market norms are different to those of social norms.
