Monday, August 9, 2010

Tomatoes and Suits

In the past few weeks, I had been engrossed with some new areas of research and reading. It kept me away from this blog, I liked the knock knock comment it made me smile. I have always been fascinated every time I learn something new. The child in us always gets excited when we learn something new and in order to keep that child alive, I enjoy exploring new things.

I have always been fascinated with the area of behavioral economics and finance. Unlike traditional finance and economics, it looks at the psychological aspects and doesn’t consider human beings to simply being numbers. Something I have always noted and experienced personally.

One interesting book I finished reading (listening rather since it was an audio book) was Predictably Irrational by Dan Ariely. There are several interesting experiments that show us how not only all of us are irrational, but very predictably irrational.

One very interesting concept was how we tend to be irrational about finances and money. Let us say you were to buy a kilo of tomatoes and the shopkeeper told you will have to pay Rs. 30 for a kilo. Now you know that if you walk for 10 minutes you can get the same tomatoes for Rs. 15 at another store, let us say in bulk at Food Bazaar, would you walk for 10 minutes?

Most people questioned said they would walk for 10 minutes to save Rs. 15. Probably you would too.

Now let us say in the next case you had gone to buy a nice luxurious Raymond full suit. It was available for Rs. 10,000. You came to know that if you walk for an additional 10 minutes the same suit was available in another store for Rs. 9985. Basically it was available Rs. 15 cheaper. Would you walk that distance to get the discount?

Most people questioned in this instance refused to walk an additional 10 minutes to save Rs. 15 on their Rs. 10,000 suit.

But if you think rationally, both cases have a similar impact to your net worth. If you walk for an additional 10 minutes in both cases you will save Rs. 15. Yet people anchor their decision on the larger price they are paying. This is predictably irrational and makes no sense if you observe from an independent view.

The same things happen a lot with a lot of people. When people are buying a car for Rs. 10 lakhs they don’t mind spending a lakh extra on leather seats. But at home, they might think twice before spending that much on their sofas. Based on such experiments and observations, we can become better investors and learn a lot more about how humans behave.

Human beings are truly exciting because of such things. Irrationalities – specially the predictable ones can be used to capitalize on opportunities and mistakes which might be made by the masses.

Every time we learn something new it makes us realize how little we know, and how vast this universe is. Yet, sometimes so many of us get caught up in things that are extremely petty and irrelevant. Smile at what might seem to trouble you today, it really won’t matter that much soon.

Go out there and explore the universes! As a fellow traveler I would suggest you pay a visit to authors like Dan in this journey.

Keep smiling, learning and having fun!

Yogesh Chabria

Happionaire

12 comments:

Anonymous said...

Welcome back..... Does the book say about the % of savings is co-related? If you look the example of tomato it is 50% off other one a fraction%. Also when it comes to tomatoes.. it is something which u consume daily.... where as u buy a sofa or suit may be once in 5 years .. so see that difference.... what is ur observation?
Regards

Sumeet said...

Hi Yogesh Ji,

Welcome back. I used to login to your blog daily just to check thoughts of wisdom and now more than 1.5 months you have written something for us. Thanks for sharing your thoughts. The most difficult part of investing is managing our emotions and its really challenging for all of us.

This is great post. I was just watching Dan Ariely talks on TED. Thought to share the link in case some fellow happionaire want to see the same. This is really a good video. Here is the link:
http://www.ted.com/talk/dan_ariely_on_our_buggy_moral_code.html

DPM said...

Hi Yogesh,
Thanks for this story. Could you please list a set a books on this blog.
Thanks

Cyril said...

Hi Yogesh,

I have been reading your blogs for about 2-3years now and enjoy them always. In this blog, I would like to say why most people would go the extra 10mins to buy tomatoes Rs15 cheaper is because its a daily commodity. They need to to buy it atleast every week. The same person would not be buying a Raymond Full Suit every week. So I think that makes a lot of sense. If I had to buy my tomatoes once a year or once a life time, i would not walk tht 10mins. But i would surely walk tht 10 mins if I have to buy it every so often.

Cyril

santosh reddy vancha said...

excellent perspective!

Arivou said...

Nice one:)

Sumeet said...

@Cyril: What Yogesh wanted to point out here is the difference b/w rational and irrational thinking. At One instance you are trying to save 15 INR on the other instance you don't bother. Tomato is a daily consumable commodity but there are N number of other instances in our life wherein we just stop thinking about saving those 15 INR. We possess Irrational thinking(without much understanding). People spending lot of money on their car seat covers which is not of much use but they ignore to spend the money on their sofa set which is being used by more than their car seat covers. This is all because we never pay attention on our thinking patterns. In Yogesh's example 15 INR means absolute 15 INR saving in both the cases and don't forgot this is a blog related to Investment and saving so thought should be to invest wisely or save wisely. Would you pay 15 INR more for SBI stock if you can get it 15 rupee cheaper price or would you like to save the same amount for any mid cap stock of lesser value!! Choice is yours!

Anonymous said...

Hi Sumeet...

No arguments on the message/ no offence to your explanation..... but to me Cyril put a valuable point. Point we should take is.. does that effort you put to get 15 Rs is worth 15 Rs.... (may be take it as % or what ever). Coming back to your qn.... I do not mind the price diff of 15 Rs on SBI stock provided SBI stock is priced high as say 2000 rs.... because.... for me
1. I am not buying 1 stock on SBI, I'll take some good number when I purchase and over long run this 15 rs will not affect that much on ur return unless I go and buy SBI stock worth crores of Rs.
2. If price of SBI stock is 30 RS.. yes 15 rs will matter to me

Point is in rational/irrational behavior... the value of the material u get for the money is what you compare to decide what to do.... If tomato costs 5000rs/Kg.. 15 rs doesn't matter to me.. I guess Yogesh also tries to show that point only.

Vrajesh Thakker said...

Dear Yogesh

I am regular reader of your Blogs and have also read both of your Books, The Happionaire Way and Cash the Crash.

I truely appreciate the way you thought and write and the examples which you give for better understanding.

I was too waiting for your Blog as have not got any updates from you for quite some time.

I red this Blog, I am sure with this story of Saving Rs 15 in both the situation, you are trying to say some thing, but I am unable to understand as where and how this is applicable in investing and how this concept can be used in investing.

I will appreciate if you can explain this as how we can use this in investing.

Regards

Vrajesh Thakker

ritesh said...

Hi Yogesh

I totally share your (and Dan's) prespective on rational and irrational thinking. Let me extend this logic for another set of people who would while buying a tomato for Rs 40 think that why crib for Rs 15 when we do not bother about it while eating out every other day!! Such people would end up paying more... always!! Some of us might think of being rational in our thought as being stingy but that's the crux of Dan's book.
Regards
Ritesh

The Happionaire™ Blog said...

My tomatoes example was random. I didn't think about the aspect that since people buy tomatoes regularly they will think differently as compared to a suit which is not purchased everyday. Let us replace tomatoes with spoons - most people will still behave in the same. way. It is illogical to compare in terms of percentage here, but still our mind does that.

In the stock market too, many times our mind thinks that a Rs. 5 stock is cheaper than a Rs. 50 stock. It might be in price, but is it in terms of value? Just a few thoughts that can get our mind to think.

Yogesh Chabria
Happionaire

Anonymous said...

Took me time to read the whole article, the article is great but the comments bring more brainstorm ideas, thanks.

- Johnson