Tag Archives: Investment

WHY THE LAST COOKIE IN THE JAR MAKES YOUR MOUTH WATER Scarcity Error

Posted on by under Behavioral Finance

When we see that something is different, unique, and having a shortage then we love to own it. That things attract us and we see them as more valuable than others. Rare is valuable. The scarcity error is as old as mankind.

We need to assess products and services solely based on their price and benefits. It should be of no importance if an item is disappearing fast, nor if others are also interested to buy it.

Business – Many business houses try to attract customers by creating a scarcity of their products. They show the availability of only a limited number of products which forces customers to make any impulsive decisions. When we make an impulsive decision then we scarify rational thinking. 

Investment – Few listed businesses are unique, different than others, well managed. Such businesses are few so People are attracted towards such businesses and suddenly those become more valuable and started trading at a higher valuation. This is what we have experienced about the quality companies in the recent stock market cycle.

Many times, businesses getting premium as an only listed company on the bourse but that should not be the only reason to invest in a company or to give a higher premium to the business. People mostly fear missing out (FOMO) particular opportunity and run behind it, so that float available for a particular stock starts reducing and demand for it starts increasing which will increase the price of a stock.

We should check whether the company has fundamental value compared to the price commanding on the bourse. If the company is not fundamentally stronger then it is no right way to chase uniqueness of business or only listed company or low shares floating in the market. We should have well-defined philosophy to invest in businesses and if the stock does not fall under it then we must avoid it. Also, we should not take a speedy decision, speedy decisions can be harmful. We are not going to miss any opportunity, the market has thrown opportunities before our birth and also going to throw after our death. We remain or not, opportunities in the market always are there to serve.

This entire series will be review with various examples from books which are “Thinking, Fast and Slow” and “The Art of Thinking Clearly“.

WHY EVIL STRIKES HARDER THAN GOOD Loss Aversion

Posted on by under Behavioral Finance

Many of the time, we have to make decisions from options, there is a risk of loss and an opportunity for gain, and we must decide whether to accept the gamble or reject it.

It has been proven that, emotionally, a loss ‘weighs’ about twice that of a similar gain. Social scientists call this loss aversion. “Losses loom larger than gains” and that people are loss averse.

Business – When we show fear of loss to people and sell our products then it will become easy to sell our products to them. The firm has its own entitlement, which is to retain its current profit. If it faces a threat of loss, it is allowed to transfer the loss to others.

Investment – When there is an increase in a stake, our loss aversion also increases with it. When we have invested in stocks and the price of it falls and we know that we have incurred loss but we do not book it. So, we sit on the stock, even if the chance of recovery is small and the probability of further decline is large. If we book loss then it becomes real and that is more painful. Fear of loss stops us from booking loss though it has already been incurred.

We should make a basic calculation of what would be future cash flow generation from the company and what if our assumption get fails. These basic calculations help to understand the risk and return scenario so that we can make a rational decision. And also, can use the margin of safety concept properly. We should be ready with a calculation that mentioned what can be a probability of losing some % of our current net worth if an investment does not work according to our plan so that we get mentally prepared in advance and also make a decision accordingly.

This entire series will be review with various examples from books which are “Thinking, Fast and Slow” and “The Art of Thinking Clearly“.

WHY YOU’LL SOON BE PLAYING MEGATRILLIONS Neglect of Probability and Prospect Theory

Posted on by under Behavioral Finance

Problem 1: Which do you choose?

Get Rs.900 for sure OR 90% chance to get Rs.1,000

Problem 2: Which do you choose?

Lose Rs.900 for sure OR 90% chance to lose Rs.1,000

What we will choose in problem 1 and problem 2?

When this is asked, the majority of us choose sure Rs.900 in problem 1 and second option while it comes to problem 2. We performed risk-averse behavior during problem 1 but risk-taker during problem 2. Here, also we neglect probabilities, we get fearless when we have the option to zero loss. And above zero, we will have fear.

The (negative) value of losing Rs.900 is much more than 90% of the (negative) value of losing Rs.1,000. The sure loss is very aversive, and this drives you to take the risk.

But when we do mathematics then only, we can understand that both options in both the problems are similar.

Getting Rs.900 for sure or Rs.900 which is 90% of Rs.1000. And a loss of Rs.900 or Rs.900 which is 90% of Rs.1000.

Our psychological factors affect us for making such decisions. We differently behave to profit and loss. Here, counter to the utility theory is, – our risk behavior does not get changed with our net worth. we also know that our attitudes to gains and losses are not derived from our evaluation of wealth.

Investment – When we have uncertainty, people fear to invest. But when things start becoming certain everyone rushes for investment. This is a reason why people come to invest when the market is near an all-time high because they get sure that they will not face loss now.

If we focus on probabilities then we can make a wise and rational decision that helps us to progress further. We should assign probabilities to the occurrence of different events so that we have statistical support to make a wise decision rather than just make it with support from emotions.

This entire series will be review with various examples from books which are “Thinking, Fast and Slow” and “The Art of Thinking Clearly“.

THE CALAMITY OF CONFORMITY Groupthink

Posted on by under Behavioral Finance

When we work in a group than as social animals, our thinking and decision get influence by the thinking of the group. Slowly we start losing our own identity of thought process. People who are opposed to the decisions or overriding opinions of the group as a whole frequently remain quiet, preferring to keep the peace rather than disrupt the uniformity of the crowd. Those who question the group are often seen as disloyal or traitorous.

If you ever find yourself in a tight, unanimous group, you must speak your mind, even if your team does not like it. Question tacit assumptions, even if you risk expulsion from the warm nest. And, if you lead a group, appoint someone as devil’s advocate. He will not be the most popular member of the team, but he might be the most important.

Business – When a team member / BOD expresses an opposing opinion or questions the rationale behind a decision, the rest of the team members work together to pressure or penalize that person. This will lead to a lack of innovation or lack of avoidance of risk. Businesses will follow what the industry is doing. Businesses should appoint a person who acts as an opponent of any view which can help to generate different perspectives and better decision making. The company also has to work towards protecting that person. Because uniform group sees different opinion and a person as an inferior, also treat him differently. They need to allows team members to contribute individually, with no knowledge of a group view, and with little or no penalty for disagreement. This can be very difficult in today’s era of technology. But one can keep a penalty for similar views which can invite different opinions.

Investment – When everyone comes to us for investing in a particular company, we have to work as a devil advocate to counter that investment idea. Because that will help us to see positive as well as the negative side of the company. If we get to agree with what the group has decided then it may be possible that we ended up with huge losses. And only seeing one positive or negative side of an investment can be harmful to us in the longer term. We need to see both the side properly with all supported data without getting biased on one side. If we like any investment then have to prepare a document which says why we should avoid investment. And if we dislike any investment then have to prepare a document which says why we should invest in that, what lead to miss out of the opportunity.

This entire series will be review with various examples from books which are “Thinking, Fast and Slow” and “The Art of Thinking Clearly“.