Fooled by a Percentage Into Catching Falling Knife! - by Sanjay Bakshi

One of my favorite experiments in class involves asking my students the following question:

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“Suppose that you visit a furniture store in a mall to buy a lamp for your bedroom. You find a lamp you like and it has a list price of Rs. 5,000. Happy with this deal, when you approach the sales representative ready to buy the lamp you picked, she informs you that one of their stores which is just a ten-minute walk from there is closing down and you can buy the same lamp over there for Rs 1,000 less. Please raise your hand if the 20% discount is sufficient incentive for you to walk ten minutes to the other store to buy your lamp.”

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About 70% of the students raise their hands.

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My next question is then addressed to only those who raised their hands. I ask them:

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“Suppose that you visit a car showroom to buy a car and after checking out many models, you find one you like. It costs Rs. 500,000, you are told by the sales representative. However, she also informs you that one of their showrooms which was just a ten-minute walk from there is closing down and you can buy the same car over there for Rs. 499,000 or Rs. 1,000 less. How many of you would like to walk ten minutes to go over to the other showroom to save Rs. 1,000?”

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I hardly see a hand raised.

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Somehow, students who were happy to walk ten minutes to save Rs 1,000 on a lamp are reluctant to walk ten minutes to save Rs. 1,000 on a car!

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What is going on here?

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Indeed, when I reframe both questions again, in a different form, students appeared puzzled:

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“Would you walk ten minutes to increase your net worth by Rs. 1,000?”

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In the lamp vs. car experiment, students who chose to walk ten minutes to save Rs 1,000 while buying a lamp but who refused to walk ten minutes to save the same amount of money while buying a car, were suffering from “anchoring bias”. Their minds were latching on to the wrong anchor of a large percentage savings on a list price, instead of latching on to the right anchor of their personal net worth.

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Related link: Presentation by Whitney Tilson - How to Avoid - and Profit From - Manias, Bubbles and Investor Irrationality

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Books:

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Poor Charlie's Almanack

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Seeking Wisdom

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Influence: The Psychology of Persuasion

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Why Smart People Make Big Money Mistakes

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The Winner's Curse

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Nudge

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Irrational Exuberance

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Against the Gods: The Remarkable Story of Risk

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Behavioural Investing

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How We Know What Isn't So

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Filters against Folly

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Everyday Irrationality