Posted in Unlearning
Question #18: This is another two part question: a) does $50 always equal $50; and b) which amount of money would you prefer to earn over a three year period $110,000 or $150,000?
While it is true that $50 will always equal $50 and $150,000 is, of course, more than $110,000; it is also true that many people ignore these obvious facts and work contrary to their financial interests. If you see a little of yourself in either of the below examples, you may need to unlearn some of your financial behaviors.
Let’s first consider the case of the $50. If you were about to purchase a $100 mobile phone and then suddenly learned the same model was being sold for $50 on the opposite side of town would you drive across town to save the extra $50? When surveyed an overwhelming number of people stated that they would.
So far so good.
When the scenario was switched, however, and the product in question was a $40,000 automobile and they were informed the same model was available at on the other side of town for the price of $39,950—or the exact same $50 savings—a majority of people indicated they wouldn’t make the trip.
The reason is that a $50 savings off a $40,000 product is miniscule compared to its overall price. Whereas, from the perspective of a $100 product, a $50 savings is quite significant. The reality is that a $50 savings is a $50 savings and a person’s wallet or bank account doesn’t know or care how they accumulated the extra savings. In a perfectly rational world people would work to save $50 regardless of the situation.
One real world manifestation of this behavior can be found in retail shops. It is a well known tactic that if a person were to go into a high-end retailer and tell the sales clerk they were interested in buying some socks, shoes and a suit the clerk would first attempt to get them to buy the suit. Why? Because if they are successful at selling the customer a $1500 suit, a $300 pair of shoes and $40 for a pair of socks suddenly seem less consequential. If, however, the customer were to begin shopping for socks first, not only would be less likely to spend $40 on socks, he would also likely to think longer and harder before dropping any money on expensive shoes and suits.
The second question stems from another fascinating study in which people were provided a choice between two different scenarios. In the first, they earned $30,000 in Year One; $40,000 in Year Two; and $50,000 in Year Three. In the other scenario, they earned $60,000 in the first year; $50,000 in the second; and $40,000 in the third.
When asked to select which scenario they would prefer, a surprising number chose Option 1. This is in spite of the fact that they would earn only a total of $30,000 less. (In Scenario 1 the total equals $110,000 and in Scenario 2 it equals $150,000). It is well documented that many people experience the pain of losing money more (as is experienced in Scenario #2) and will go to great lengths—including missing out on an extra $30,000—to avoid that pain.
For a real world implication of this behavior, consider the case of a bargain flight from San Francisco to New York. Imagine the price is $300 on Monday but suddenly jumps to $400 on Tuesday. Many people will skip the deal. If, however, the same flight was originally $800 and then dropped to $600, more people would rush to book the flight because it was a “deal”—even though it is $200 more expensive than the first scenario.
Often, people prefer the illusion of a good deal (a $600 flight that was $800) to the reality of a much better deal (a $400 flight that was $300). My advice: Don’t always follow the money because sometimes it can lead you astray.
Homework assignment #18: Which are you more likely to sell: A $50 stock that has appreciated $25 or sell a $50 stock that has declined by $25? Explain and defend your answer.
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