john's friend Allan bought a house five years ago for $200,000.
Four years later, Allan's company moves to another city. The local real estate market is depressed. He is offered $170,000 but feels he can't afford a loss. So he waits another year and this time the offered price is $150,000.
Isn't it better for Allan to concentrate on what the house is worth rather than on what he paid?
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John kept pouring dollars in the machine. ''I got Cherry, Cherry, Bar. Tm close now. " We want and place higher value on something when we almost have it and lose it. Charles Munger says, "One reason why horse races, bingo and these things have always been so popular is because of all these near misses." Frequent near misses are like small reinforcements and make us want to try again and again.
Just as people take larger risks when threatened, after a loss, we want to catch up, so we end up taking more risks to get even. But as Warren Buffett and Charles Munger say:
Buffett: A very important principle in investing is that you don't have to make it back the way you lost it. In fact, it's usually a mistake to try to make it back the way you lost it.
Munger: That's the reason so many people are ruined by gambling - they get behind and then they feel like they have to get it back the way they lost it. It's a deep part of human nature. It's very smart just to lick it - by will...
Buffett: One of the important things in stocks is that the stock does not know that you own it. You have all these feelings about it: You remember what you paid. You remember who told you about it - all these little things. And it doesn't give a damn. It just sits there. If a stock's at $50, somebody's paid $100 and feels terrible; somebody else has paid $10 and feels wonderful - all these feelings. And it has no impact whatsoever ...
John and Mary's daughter didn't want the toy they gave her; she wanted the toy they didn't give her.
Michel de Montaigne said: "To forbid us something is to make us want it." We want what we can't have. Forbidden fruit tastes best. Mark Twain said, "It was not that Adam ate the apple for the apple's sake, but because it was forbidden. It would have been better for us - oh infinitely better for us - if the serpent had been forbidden." Forbid someone to do something and they find it more attractive than they did before it was forbidden. For example, when Miami banned the use of phosphate-based detergents, people turned to smuggling in supplies and hoarding (since fear of scarcity encourages hoarding) and even rated the banned products as better than before.
"Since a real estate lot in this area is both rare and hard to obtain, I want it. "
We want and value more what is scarce or unique. We want what is (or threatens to be) less available. The less available it is, the more we desire it. That's why we subscribe to newsletters containing exclusive and restricted information. And why we participate in initial public offerings and buy stocks on hot tips.
We value higher what has recently been less available than things that have
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been scarce all along. We fall for limited offers and deadlines like, "The offer ends at midnight. We only have a few left. This is the last chance. "By making things less available, merchants make them seem more valuable.
lot of people are competing for this lot at the auction."
How do we create demand? Create competition. Make people perceive there is a huge competition for the item and limit the number of people that can participate in the bidding. If others want what's scarce, we want it even more.
When we can't get something, we lower our opinion of it. When we can get something that others don't want, we don't want it either.
Keep in mind
Know your goals and options. Ask: Why do I want this? For emotional or rational reasons?
What you paid for your house, stock, or car has no relevance to its value. If the
value is below what you paid, you don't have to get even. If you bought a stock for $100 and it is now $50, you should sell it, if it is not worth more than $50. Ask: Suppose I hadn't made the investment, would I make this investment today at today's price?
Remember that people respond to immediate crisis and threats. Anything that happens gradually, they tend to put off. If we want people to take a risk, we should make them feel behind (losing). If we want them to stay with the status quo or reject risk, we should make them feel safe.
Charles Munger shows how we can use the force of deprival to persuade (for a reputable reason):
In Captain Cook's day, he took these long voyages. At the time, scurvy was the dread of the long voyage. And in scurvy, your living gums putrefy in your mouth - after which the disease gets unpleasant and kills you. And being on a primitive sailing ship with a bunch of dying sailors is a very awkward business. So everybody was terribly interested in scurvy, but they didn't know about Vitamin C. Well, Captain Cook, being a smart man with a multiple-model kind of approach, noticed that Dutch ships had less scurvy than English ships on long voyages. So he said, "What are the Dutch doing that's different?"
And he noticed they had all these barrels of sauerkraut. So he thought: 'Tm going on these long voyages. And it's very dangerous. Sauerkraut may help." So he laid in all this sauerkraut which, incidentally, happens to contain a trace of vitamin C. But English sailors were a tough, cranky and dangerous bunch in that day. They hated "krauts". And they were used to their standard food and booze. So how do you get such English sailors to eat sauerkraut?
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Well, Cook didn't want to tell 'em that he was doing it in the hope it would prevent scurvy - because they might mutiny and take over the ship if they thought that he was taking them on a voyage so long that scurvy was likely.
So here's what he did: Officers ate one place where the men could observe them. And for a long time, he served sauerkraut to the officers, but not to the men. And then, finally, Captain Cook said, "Well, the men can have it one day a week."
In due course, he had the whole crew eating sauerkraut. I regard that as a very constructive use of elementary psychology. It may have saved God knows how many lives and caused God knows how much achievement.
STATUS Quo AND Do-NOTHING SYNDROME
Nothing will ever be attempted if all possible objections must first be overcome.
Samuel Johnson
When john and Mary bought their new car, they stuck to their usual brand.
We prefer to keep things the way they are. We resist change and prefer effort minimization. We favor routine behavior over innovative behavior.
The more emotional a decision is or the more choices we have, the more we prefer the status quo. This is why we stick with our old jobs, brand of car, etc. Even in cases where the costs of switching are very low.
'1 fear the social consequences if I make the wrong choice, so I decide to do nothing. " We want to feel good about the choices we make so we can justify our actions for others and ourselves. We are more bothered by harm that comes from action than harm that comes from inaction. We feel worse when we fail as a result of taking action than when we fail from doing nothing.
We prefer the default option, i.e., the alternative that is selected automatically unless we change it. In a real-life experiment on auto insurance rates, car drivers in New Jersey and Pennsylvania were given the choice ofa limited right to sue for pain and suffering in exchange for lower insurance rates. But the default option was different for each state. Car owners in New Jersey were automatically given the limited right unless they made an active decision and said differently. In Pennsylvania, the default option was the full right to sue. What happened? Citizens of both states preferred the default option. 79% of New Jersey drivers preferred the limited right to sue, whereas 70% of Pennsylvania drivers preferred the full right to sue. The difference in amount spent on insurance in the two states was about $200 million. The preference for defaults has also been found in decisions about organ donation, health care plans, and pension savings.
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Sometimes we don't act when we know we should. We
ignore Warren Buffett's Noah principle: "Predicting rain doesn't count; building arks does."
"Why invest resources in something today since we don't get any credit for preventing something we don't even know will happen. "
We often ignore distant problems and we are reluctant to prevent future threats. Warren Buffett says: "It took Noah 20 years to build an ark. And people said he was being silly because the skies were beautiful. And of course, the whole time, he looked stupid- until it started raining. You can spend a long time building an ark while everybody else is out there enjoying the sun."
Keep in mind
Deciding to do nothing is also a decision. And the cost of doing nothing could be greater than the cost of taking an action.
Remember what you want to achieve.
Once we know what to do, we should do it. The 19th Century British biologist Thomas Henry Huxley said: "Perhaps the most valuable result of all education is the ability to make yourself do the thing you have to do when it ought to be done whether you like it or not. It is the first lesson that ought to be learned and however early a person's training begins, it is probably the last lesson a person learns thoroughly."
IMPATIENCE
The CEO ofTransCorp wants his bonus today and therefore he makes a decision that increases this year's profit at the cost of a possibly larger profit in the foture.
We give more weight to the present than to the future. We seek pleasure today at a cost of what may be better in the future. We prefer an immediate reward to a delayed but maybe larger reward. We spend today what we should save for tomorrow. This means that we may pay a high price in the future for a small immediate reward. For example, we buy things we can't afford on credit cards.
We are impatient in the short run and patient in the far away future. Studies show that we tend to become less patient when rewards are more immediate. Our discount rates (the values we assign to something) are higher in the short run than in the long run. For example, when a small reward is due tomorrow and a larger reward is due in one year, people often prefer the small immediate reward. But when the small reward is due in one year and the larger reward in two years, people tend to prefer the larger long-term reward. Studies show that one explanation for this is that outcomes occurring in the future are perceived as less certain.
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Keep in mind
Michel de Montaigne said: "I conceive that pleasures are to be avoided if greater pains be the consequence, and pains to be coveted that will terminate in greater pleasures." Consider both the short and long-term consequences of a decision. Weigh present good/bad against future good/bad. Short-term suffering may lead to long term pleasure.
IO. ENVY AND JEALOUSY
Man will do many things to get himself loved; he will do all things to get himself envied.
-MarkTwain
Aristotle said: "Envy is pain at the good fortune of others." We evaluate our own situation by comparing what we have with what others have. Aristotle continues: "We envy those who are near us in time, place, age or reputation." It is people similar to us we envy most. Financial historian Charles P. Kindleberger says in Manias, Panics, and Crashes: "There is nothing so disturbing to one's well-being and judgment as to see a friend get rich." For example, studies show that how happy we are is partly determined by where we stand in relation to similar others. The 19th Century German philosopher Arthur Schopenhauer said: ''As Hobbes observes, all mental pleasure consists in being able to compare oneself with others to one's own advantage."
We are jealous when we perceive a threat to a valued relationship. Studies show that jealousy is ranked among the top three motives for murder.
Keep in mind
Bertrand Russell said that envy is one of the fundamental causes of human suffering. The 18th Century French philosopher and mathematician Marquis de Condorcet said: "Enjoy your own life without comparing it with that of another." As long as you achieve your goals, it shouldn't matter if someone else does better.
Studies show that it matters whether we believe that others deserve their success. Aristotle said: "The best way to avoid envy is to deserve the success you get."
On the other hand, the 18th Century Dutch physician Bernard de Mandeville said that vices such as greed, envy, and vanity all lead to public benefits by encouraging enterprise.
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II. CONTRAST COMPARISON
Fill one bucket with cold water, another with hot water, and a third with water at room temperature. Put one hand in the bucket of cold water and the other hand in the bucket of hot water. Then put both your hands in the bucket of room temperature water. What happens? You will feel that your cold hand feels warmer and that your warm hand feels colder.
We judge stimuli bydifferences and changes and not absolute magnitudes. For example, we evaluate stimuli like temperature, loudness, brightness, health, status, or prices based on their contrast or difference from a reference point (the prior or concurrent stimuli or what we have become used to). This reference point changes with new experiences and context.
This means that how we value things depend on what we compare them with.
The grossly overpriced $100 tie seemed reasonable after john bought the fairly priced
$1,500 suit.
The order in which something is presented matters. Sales people often try to sell the more costly item first. We are out buying a computer and some diskettes. In comparison to $1,500 computer, diskettes at $10 seem like a bargain. After we buy the big ticket items, the add-ons seem cheap in comparison.
Experiments have shown that we go across town to save $10 on a clock radio but not to save $10 on a large-screen TV. The difference between $100 and $110 seems like a larger saving than the difference between $2850 and $2860. But it's the same $10 saving.
"What I am used to getting in social benefits is the norm against how I measure fairness,"says john's friend Mark.
A hotel has been renting rooms for $100 a night. The day after a hurricane, the hotel raises its prices to $150. Studies show that we consider this unfair. We determine what is fair or not in reference to what we have been used to. This means that policies that have habit-forming consequences may be hard to reverse if they are seen as a loss.
One ofTransCorp's subsidiaries developed a high-priced version of the machine. Even if it doesn't sell well, it will help induce customers to buy their cheaper (but still expensive) version.
The same thing may appear attractive when compared to less attractive things and unattractive when compared to more attractive things. For example, studies show that a person of average attractiveness is seen as less attractive when
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compared to highly attractive others. Charles Munger gives another example: "In my generation, when women lived at home until they got married, I saw some perfectly terrible marriages made by highly desirable women because they lived in terrible homes. And I've seen some terrible second marriages which were made because they were slight improvements over an even worse first marriage."
In one experiment, a group of people was asked to choose between $6 and an elegant pen. Most choose the cash. Another group of people was asked to choose between $6, the elegant pen, or an inferior pen. Most choose the elegant pen. By adding an inferior option, another option seemed more attractive.
Mary is looking at houses. The real estate broker knows that the house he is trying to sell Mary is in poor shape and a bad area. He starts by showing Mary bad properties in an ugly neighborhood. Afterwards, he takes her to the house he wanted to sell all along. Suddenly this house and the area seem great in comparison to the other houses she saw.
Another example of contrast comparison is when we interview one job candidate after another.
"If we slowly and gradually over time manipu/,ate the numbers, the auditors won't notice it."
Contrasts may blind us to change until it's too late. For example, we often don't notice the bad behavior of others if it goes sour gradually over time.
&
nbsp; Often we see reality as constant, although it gradually changes. A stimulus must reach an absolute threshold before we can detect it. Before we notice a change in a stimulus, a certain relative change most occur. If the change is slow enough, we don't notice the change. Our ability to detect and react to changes in a stimulus decreases as its magnitude increases. To a small stimulus, only a small amount must be added. To a larger stimulus, a large amount must be added.
Sometimes it is the small, gradual, invisible changes that harm us the most. Warren Buffett says: "One of the problems in society is that the most important issues are often these incremental type things." He continues:
The world is not going to come to an end because tomorrow there are 200 or 250 thousand more people on the planet than there were today. That's about the number it grows every day... it is like eating about 300 calories more each day than you burn up; it has no effect on you today. You don't get up from the table and all of a sudden everybody says, "My God, you look fat compared to when you sat down!" But, if you keep doing it over time, the incremental problems are hard to attack because that one extra piece of piedoesn't really seem to make a difference. The 250,000 people tomorrow don't seem to make any difference, but
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