Hello friends, in today’s article we see the decision paralysis bias from the book stocks to riches chapter 6. In this, the author i.e. Parag Parikh gives wonderful examples that help us to understand this concept. so if you have some decision paralysis bias, then you have to read this article, and understand it, to avoid the decision paralysis bias.
Decision Paralysis and The endowment effect:-
for starting the author give wonderful examples, and then we try to understand the decision paralysis in detail, let’s start with examples,
Roopesh ( a businessman) has come to meet with Satish ( a portfolio manager).
Roopesh:- I am a businessman I have inherited from my father a portfolio of various stocks. He was an investor and he died five years ago. I’ve always wanted professional help on handling my portfolio as I know nothing about stocks and My own business keeps me busy.
Satish:- it would be a pleasure to construct a good portfolio for you. I have been in this profession for the last 20 years and have many high net worth individuals and corporates as my clients. could I have a list of your stocks?
Roopesh:- Here it is, Can we discuss it right now? I have already wasted five years doing nothing.
Satish:- At a glance, I can see that it is a very lopsided portfolio and drastic changes are required to balance the industry weightage. A number of stocks will have to be sold as they are not viable. Had you done something about the portfolio immediately after your father died you would not have been saddled with so many junk stocks? since we need to act quickly I will put my comments on this sheet. (Decision Paralysis)
Roopesh:- Oh, thank you so much for understanding the urgency of the situation and working on it the right way. I will get everything in order and meet with you the day after tomorrow.
Satish:- That’s may not be possible as I am extremely busy, how about next week?
Roopesh:- Satish, you know the urgency so please spare some time for me. I will adjust my schedule.
Satish:- Is 4. P.M. okay with you?
Roopesh:- It’s perfect. Thanks for squeezing me in I just need to get over this. I am so indebted to you for your time.
they meet at the scheduled time.
Roopesh:- I did some homework and I have a few queries.
Satish:- Please go ahead, I will clarify all your doubts.
The meeting goes on for an hour. Initially, Roopesh’s questions are the same but Satish is patient and clarifies all his doubts. the meeting ends with Roopesh scheduling another appointment after a couple of days.
Roopesh:- Thank you once again for your time You know how urgent this is for me so before I finalize I brought my wife along so that she too is clear about everything. Meet my wife Meena
Satish:- Nice meeting you. Now, what can I do for you? I hope your husband has explained everything to you. If you have any questions don’t hesitate to ask.
Meena:- I am just a housewife. I do not understand investments. My husband insisted that I come as he wanted to finalize some business with you. He told me that you are an expert in your field and he trusts you very much. I am happy that he has ultimately taken a decision after five years. (Decision Paralysis)
Roopesh:- Yes, I am glad I have met the right portfolio manager. now to complete the formalities and take action, shall we meet tomorrow? Please give me an appointment as this matter is my first priority.
Satish:- Okay. since we will require time to finalize, let’s make it 6 P.M. tomorrow.
Roopesh:- thank you very much. I will be there. I will bring my wife too in case you need her signature. goodbye.
The next morning, Roopesh calls Satish’s secretary and asks her to reschedule the meeting two weeks later, Roopesh walks in with a gentleman.
Roopesh:- Satish, meet my friend Atul. He is a leading chartered accountant. before finalizing. I thought he should meet with you and you can clarify his doubts. I hope you don’t mind.
Satish:- Yes, Atul please go ahead with your questions,
Atul:- I have heard a lot about you. I have nothing to ask a professional like you. I know Roopesh Is in safe hands. Roopesh, I know of Satish’s reputation and you can be assured that you have got the best professional working for you.
Roopesh:- thank you. Now Atul has given me the green signal I do not have any hesitation. I will call tomorrow and fix a time so that I can bring my wife and we can complete the formalities.
the next day Roopesh calls Satish’s secretary and asks for an appointment after three weeks as he has another urgent business appointment the secretary refuses to reschedule the appointment.
I know while reading these examples, we can’t get any logical sense, so read the following explanation to understand the logic of the above examples. (Decision Paralysis)
After these examples, the author explains about above examples.
the author says, ” Why did the secretary do that, especially after Satish had spent so many hours with a prospective client and the signing was a near certainty? What do you make of Roopesh’s behavior? Why was he post poring his decision? Suffers from decision paralysis. He can not make decisions and is resilient to change Satish had lost trust in him. He guessed that nothing would make him act. To buy time Roopesh went on a business trip, then bought his wife along, and after that his friend Atul. His wife and his friend were not even informed about the talk. He had had with Satish and neither was competent enough to ask Satish any worthwhile questions though Roopesh harped on the urgency of the matter and insisted that it was a top priority he just could not decide what to do. Perhaps he has been behaving this way earlier as well. He fears change, so he prefers maintaining the status quo.”
He understands that he needs to take action but he can not.
then the author explains decision paralysis or Status quo bias.
the author says, ” this phenomenon hampers us in many areas of life, from choosing an investment option to buying a house. Once you are familiar with the complicated forces at play you will understand why choice and change can be so intimidating.
A significant sequence of decision paralysis in financial decisions is that by deferring purchase you may miss the opportunities or run the risk of prices-rising. Imagine there is a very good house for sale. You like it because it suits all your requirements and the prices seem right. But you can not decide and opportunity to see a few more houses. With multiple choices a decision is difficult. As time passes another bidder enters the fray and you lose the opportunity. Because of decision paralysis, you lost the house.”
then the author explains, what factor needs to be making decisions.
In this author explain the different factors that need to take decisions
the author says, ” We have to understand that deciding not to make a decision is also a decision. when we make a decision we give ourselves a chance to have from the present comfort zone. Once we do that we have a 50-50 chance of going right or wrong. If we choose not to take a decision we miss this chance of going right.
Maintaining a status quo in times of continuous change is definitely unwise. Another way of looking at decision paralysis is that it is a natural human tendency to resist change.
So one is the reason that is why we can’t make the decisions.
- Fear of going wrong
- the possibility of losing
- to avoid looking foolish
- Unwillingness to take risks
then the author explain the above point
the author says,” All these reasons stem from our psychological and cognitive defects. the most acute of these is loss aversion and egocentric human nature. Along with that heuristics like regret avoidance and belief perseverance also play a significant role in our mental makeup”
then the author gives the illustration story to understand better way.
the author says, ” suppose, you inherit from your rich uncle Rs. 50 lakh and you want to invest it. You buy stocks, bonds, fixed deposits, etc. according to your preference and needs. It is simple you have the money and you allocate across assets. But if you were to inherit a portfolio of stocks amounting to Rs. 50 lakh, what would you do? you need to make multiple choices. You could sell the stocks in the portfolio and buy different stocks or some bonds etc. Or you could leave the portfolio as it is. Most people would choose to leave the portfolio as it is. they would choose to maintain the status quo. when there are multiple options. One is more likely to delay on action or take no action at all the greater the choice. The harder the decision.”
Then the author explains what is investing and decision paralysis relation.
Investing And Decision Paralysis:-
In this, the author gives examples to understand this relation between investing and decision paralysis in a better way.
let’s see examples
the author says, ” Decision paralysis plays an important role in Financial markets especially when you are dealing in the stock markets. the volatility of the stock markets also adds to distorted human behavior. Most people would do nothing or as well as we call it, maintain the status quo. Here are some examples of decision paralysis at work.
- During the IT boom stocks reached new heights this went on for over a year. Those who invested in tech stocks become wealthly. a number of us, find managers and clients, thought that the markets were irrational and that the tech stocks were priced high. However, everybody wanted to ride the wave, confident that they would sell when the market softened. A fund manager of a leading mutual fund who also shared my opinion on the market. Valuations said he would sell when the tide turned. His fund had a weightage of 80 percent in the technology sector. When the market dropped it did not go down in one go. It was gradual before the steep fall come. Actually, the fund manager should have sold when the market began to weaken. He had been looking forward to such a situation, yet when the time come for him to do it he did not sell. He suffered decision paralysis and so did millions of other investors who made huge profits in the tech sector. I had consistently advised him to sell. He did not and suffered a loss when he liquidated.
- We all remember the story of the unit trust of India ( UTI) the guardian to millions of Indian investors, corporate pensions widows working class, etc. Established in 1964 it was the only Indian mutual fund where Indians invested their savings. Operating in a socialistic environment the fund was open-ended but not net asset value ( NAV) based. It consistently distributed dividends and the governments supposedly guaranteed repayment. One could enter and exit at the price made available by UTI itself. Liberalization in 1991 and the entry of private and public sector mutual funds. Soon Challenged UTI’s supremacy. Despite operating in a competitive environment it continued to follow its earlier policies. In 1995 the stock markets boomed. that was the time to make it open-ended and let investors enter and get at the current NAV. times were changing and UTI’s position was threatened. The writing was on the wall but no action was taken. The Deepak Parikh committee was appointed to advise restructuring of UTI but nothing was done. Until one day the inevitable happened. this not only shattered the investors of UTI but also shook. the stock markets and it took over a couple of years for the markets to recover.
- Another example of decision paralysis is when investors buy top-performing funds and do not reshuffle. their portfolios. they are happy since their funds are doing well. but when there is a choice of funds it is important to choose the right one, which may not necessarily be the one that has performed well. On the contrary, the chances of it sustaining its performance are much lower. By definition, a mutual fund captures the mutuality of the market so in the bull phase you should reshuffle. don’t let decision paralysis hamper your investment decisions.
- Greed and Fear are a part of the market flow excess characterize the bull phase where every stock is sellable. During such a phase all types of companies enter the capital market to capitalize on the bull run. Money becomes easily available. Investors get trapped by such stocks when the bull run ends they swear they will get out of such stocks as soon as they can. For years they prefer to maintain the status quo as they get greedy, hoping to make more money on such junk stocks.
then on these examples, the author gives a short note.
the author says, ” I have come across various examples of investors who are unable to decide and prefer to maintain the status quo. why do people behave this way? Is the prospect of change so frightening? yes, it is and the concept of the endowment effect explains it all.
then the author explains the endowment effect
to understand this effect, the author gives the two situations, and their explanation.
The author says, ” What would you do in the following situations?
1 ) You have been gifted a souvenir jug worth Rs. 100 ( in the marketplace). Someone offered to buy it from you. What is the very least you would expect to be paid for the jug?
A) Rs. 100
B) Rs. 80
C) Rs. 70
D) Rs. 50
2) Your neighbor has received a souvenir jug worth Rs. 100 ( in the marketplace) as a gift. he offers you the jug for sale. What are the most you are willing to pay for the jug?
A) Rs. 100
B) Rs. 80
C) Rs. 70
D) Rs. 50
It is obvious when someone offers to buy the jug from you, you would like to be paid Rs. 100. but when the same jug is offered to you, you would like to pay only Rs. 50 why is there such a big difference in the price offered and the price tendered when the person is the same and the jug is the name?
Because we perceive that whatever belongs to us is more valuable than that belongs to others. When something comes into our possession its value increases. In a way, this explains why people prefer the status quo to change by foregoing change in favor of the familiar they express happiness with the current situation. True, a decision to do or not to do something would be influenced by a host of other factors such as doubt, fear, or confusion.
Nonetheless, keeping things as they are is a vote of confidence for the current circumstances, irrespective of whether they are good or bad. a preference for holding on to what you have is a lot stronger than most people think.
because people place an inordinately high value on what they have, a decision to change becomes difficult. Of course, people do manage to overcome this tendency, for if they didn’t they would not sell their homes as trade their used cars, or divorce their spouses. but to the extent that the endowment effect makes it difficult, to properly value what is and isn’t yours, you may fail to pursue options that are in your best interest. In fact, the endowment effect is just another manifestation of loss aversion. people, place too much emphasis on instant gratification and too little value on Opportunity Costs.”
then the author talks about the impact of the endowment effect.
Impact of Endowment Effect:-
To understand this effect impact author gives us real-life examples, in that examples how the endowment effect is used. let’s see step by step
the author says, ” The endowment effect is very relevant to invest. Stock market participants, Analysts, Fund Managers, and companies all become victims of the endowment at one time or other. here are a few examples of the endowment effect as it plays out in real life.
Overvaluing One’s Holdings:-
Ganesh:- “ What is the price of Tata Steel?”
Broker:- ” It is Rs. 298/299 ”
Ganesh:- ” Give me a call when it reaches Rs. 300, I need to sell.”
the price reaches Rs. 301.
Broker:- ” The price is Rs. 301/302. Should I sell? It is one rupee above your limit of Rs. 300.”
Ganesh:- ” No. The market seems to be going up I will wait for a price of Rs. 305, give me a call then.”
the prices go up to Rs. 306 and the broker calls.
Broker:- “ The price is Rs. 306. What should I do.”
Ganesh:-“Wait till it touches Rs. 315. then don’t even ask me, just sell. I am sure it will go up. This is a great company and such a low price is ridiculous.”
the price falls to Rs. 301.
Broker:- “ The markets are down and the stock is back to Rs. 301.”
Ganesh:- ” The market may be down but the stock can not go down. I know we will get the price Tomorrow. when the markets are up. don’t worry we will sell tomorrow at Rs. 315. I just can’t believe that the market is selling a good stock so cheap.
After these examples author explain why Ganesh does that
the author says, ” Every time the stock went up Ganesh would increase his limit. Was he playing games? No. he is a serious investor. He strongly believes that Tata Steel is a great company. He is proud of his holding and he firmly believes that the market is undervaluing his stock.”
The Trial and Money-back Guarantee scheme:-
Raju:- ” Mom, see what I’ve got, the latest stereo system. It will fit perfectly in our drawing-room. Wait till I play it. you will love the sound.”
Mom:-” Raju, where did you get the money for such an expensive stereo.”
Raju:- ” it’s on a 15- day trial basis. the shop round. the corner allows you to use the goods before you buy. Since college is closed for two weeks. I thought I’d listen to some music at home.”
Mom:- ” Are you sure they will take it back without any fuss?”
Raju:- “ Of course mom, don’t worry. here is the card. It says that they will take it back no questions asked, it returned within the 15-day trial period.”
Mom:- ” that’s great, handle it carefully. They may not take it back if it is misused.”
Raju:- “ Don’t worry I will be careful.”
After 14 days,
Mom:- ” Raju, don’t forget the trial period ends tomorrow. we have to return it, though we will miss it.”
Raju:- ” Mom, can we keep it and make the payment A good system makes a difference. Moreover, it fits in with our decor like it was specially made for us.”
Mom:- ” Yes, you are right. let’s keep the stereo we will make the payment.”
so you get the idea of the endowment effect. (Decision Paralysis)
then the author gives us an explanation.
the author says,” Notice how taking a product on trial got Raju and his mother to buy it. the shop owner understands the endowment effect very well. he knows that once the stereo becomes a part of their endowment it will be very difficult for them to part with it. they did not find out whether the stereo is competitively priced, whether there are better models in the market, or whether some company has introduced a better model.
Because it had become a part of their endowment it become very precious to them.
Businesses understand the endowment effect too well that’s why they are willing to give their product on trial with a money-back guarantee on purchases. they know that once customers own the product, even if it is for a few days, its perceived value increases, and they may not want to return it.”
So for avoidance the investing mistakes by cause of decision paralysis and endowment effect.
the author gives us the perfect plan of action to avoid this.
so, if you want to read that plan, you can read that plan in this book, by ordering this book from the following image link
to Solve the following problems
- You have a hard time choosing investment options.
- you react adversely when your decisions turn out poorly.
- you buy products on trial but never return them.
- You delay making investment and spending decisions.
- you hold on to stocks you own.
- You go on a company visit and buy stocks
- you do not have a retirement plan in place.
So, this is all about decision paralysis and the endowment effect.
I highly recommend buying these books, from the above link,
if you buy these books, you will avoid losing millions of money on useless things.
so then buy these books, and improve your investor behavior mindset.