Tuesday, November 3, 2009

How Happy Are You?

If I were to ask you a question: How happy are you? To answer this question, you will start to look around your friends and neighbours what they have in order to judge how happy you are with what you have. This is known as "anchoring" which means we like to make decisions based on some reference points. To illustrate this concept further, there was an experiment done by a famous behavioural economist, Dan Aeriel based on an actual ad from the Economist.

There were three offers in the ad: an Internet-only subscription for $59, a print-only subscription for $125, and a combined print and Internet subscription, also for $125. When Dan gave these options to a group of students, 16% chose the internet-only subscription, none took the print-only subscription, and 84% opted for the combined subscription. Sounds reasonable ? But in his second round of experiment, he took out option 2 since no one selected it and offer the Internet-only and combined subscription options to another group of students. The results? 68% of students selected the Internet-only option and only 32% chose the combined offer.

What is wrong here? Nothing wrong, its just marketing gimmicks to take advantage of people's emotional weakness that often use the wrong things for comparisons. The above example showed that when given the price of print-only subscription is the same as the combined subscription, the latter looks like a great deal!

In stocks, we like to compare the historical prices when we make decisions. For example, we did not buy a stock at RM5 because we originally looked into it and did not buy at RM3. Buying at RM5 will make you regret more as you were making the comparisons.

With investment, we have to be rational and objective. We should try to put the past prices behind and focus on the current value and future prospects of the stock that we are buying. If we keep thinking about the lows that we've missed in March this year, we may be ended missing the whole boat altogether.

Happy investing,

Pauline Yong

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