The Dan Ariely Series: The Die is Cast and the Anchor Set

Colleagues ask how does behavioral economics help investors make money or how does it help investors pick the right stocks or make them better investors? Why can’t we just ignore this discussion about emotional biases and heuristics?

During the Berkshire Hathaway 2017 annual meeting Q&A session, Charlie Munger says:

“I think we have one other advantage. A lot of other people are trying to be brilliant, and we’re trying to stay rational… and… it’s a big advantage!”

Edited image source: Poor Charlie’s Almanac by animoumou.com

Staying rational takes conscience effort and it doesn’t come naturally. Without knowing our biases, we can’t be rational, or as Charlie eloquently puts it:

‘You’re a one-legged man in an ass-kicking contest’

Another investor whom I respect, Allan Mecham of Arlington Value Capital,  in a wonderful interview with the Manual of Ideas talks about using a two-track analysis when looking for investment opportunities:

‘It’s important to keep the litany of subconscious biases in mind when investing. Charlie Munger talks about using a two-track analysis when looking at ideas. I think that’s an extremely valuable concept to implement when looking at investment opportunities. You have to understand the nature and facts governing the business/idea and, equally important, you need to understand the subconscious biases driving your decision making — you need to understand the business, but you also need to understand yourself!’

In an experiment (by Dan Ariely, Drazen  Prelec, and George Lowenstein), college students in a classroom are shown a few random items. A handout with the items listed is given to each student. Students are asked to write their last two digits of their SSN# on top of the page. The random items are: a box of chocolates, a cordless keyboard and mouse, a trackball, a bottle of rare wine, a bottle of average wine, and a design book.

Students are then asked to write their last two digits of their SSN# next to each of the items on the list and add a dollar sign turning it into a price. Then the students are asked to bid for each of the items and write a price they’re willing to pay for each item.

When asked by the researchers, did the last two digits of your SSN# have any effect on the amount you bid? They reply was of course NOT!!

Take a second and think….. What do you think happened?

It turns out that, on average, those with SSN# ending with 80 – 99 bid more for the items, and those SSN# ending  with 01 – 20 bid less for the items. Top 20% avg $56 and bottom 20% avg $16. A 350% difference.

Does this sound rational to you? Do you think you or I are immune?

In this experiment, the SSN# was the anchor. Had the researchers used the students’ shoe size or the current temperature, the results would vary accordingly. Beware of anchoring or – as it’s known by behavioral economists – Arbitrary Coherence.

Could it be that the intricate lives we have carefully crafted are largely a product of arbitrary coherence?

The Dan Ariely series are inspired by:

John Mihaljevic of the Manual of Ideas. John Mihaljevic, CFA, is author of The Manual of Ideas, the bestselling book on value investing.Manual of Ideas.John is also founder of MOI Global, an invitation-only membership community of intelligent investors. It publishes the Manual of Ideas, “the very best investing newsletter” (Pabrai). John is also a managing director of ValueConferences, the series of fully online investment conferences for sophisticated investors. He has also served as managing partner of investment firm Mihaljevic Capital Management LLC since 2005. He is a member of Value Investors Club, an exclusive community of top money managers, and has won the club’s prize for best investment idea. John is a trained capital allocator, having studied under Yale University chief investment officer David Swensen, and served as research assistant to Nobel Laureate James Tobin. John holds a BA in economics, summa cum laude, from Yale and is a CFA charterholder.
and
Dan Ariely of Duke University. Dan is the James B. Duke Professor of Psychology and Behavioral Economics at Duke and a founding member of the Center for Advanced Hindsight. Dan’s books, Predictably Irrational, The Upside of Irrationality, The Honest Truth About Dishonesty, are NY Times best sellers. Dan also has a podcast “Arming the Donkeys”. A new book by Dan and Jeff Kreisler is expected to go on sale November 11 2017 titled Dollars and Sense.

 

 

The Dan Ariely Series: Power of Price

In Dan Ariely’s book Predictably Irrational, the famous Veladone RX experiments conducted on a college campus vividly exposes our bias to the power of price when participants of the experiment were able to withstand more pain from electric shocks taking the full-priced painkiller than those that took the discounted cheap painkiller pill.

Although we later learn that both painkillers were placebos (vitamin C), we wanted to dive into the power of price and how that affects our social decisions when making purchases that have to do with health.

In Ghana, it is not uncommon that a member of my family has malaria from time to time. A friend of mine,

Artefan 20 / 120

Basha the pharmacist, tells me there’s an alternative to the more expensive anti-malarial Coartem 3-day course by Novartis which generally costs anywhere from Ghc35 – Ghc39 equiv. $8-$9. The alternative referred to as ACT Artefan is subsidized and costs roughly $1 or Ghc5.

My understanding from Bendi, another pharmacist friend, is that pharmacies only pay the shipping of the product and Bill Gates pays the rest. Regardless what the truth behind the subsidizing authority or body, there’s an 8x price difference.

The BIG Question is: Which anti-malarial  will you buy for your sick daughter or son or spouse? Not only are they weak in bed shivering from fever with sweat dripping from their forehead, but also too weak to move or eat or drink.

Will you go for the discounted ACT or will you ask for the original fully-priced 3-day course and more expensive drug? Even though we know they’re the same, many of us go for the expensive option.

The Dan Ariely series are inspired by:

John Mihaljevic of the Manual of Ideas. John Mihaljevic, CFA, is author of The Manual of Ideas, the bestselling book on value investing.Manual of Ideas.John is also founder of MOI Global, an invitation-only membership community of intelligent investors. It publishes the Manual of Ideas, “the very best investing newsletter” (Pabrai). John is also a managing director of ValueConferences, the series of fully online investment conferences for sophisticated investors. He has also served as managing partner of investment firm Mihaljevic Capital Management LLC since 2005. He is a member of Value Investors Club, an exclusive community of top money managers, and has won the club’s prize for best investment idea. John is a trained capital allocator, having studied under Yale University chief investment officer David Swensen, and served as research assistant to Nobel Laureate James Tobin. John holds a BA in economics, summa cum laude, from Yale and is a CFA charterholder.
and
Dan Ariely of Duke University. Dan is the James B. Duke Professor of Psychology and Behavioral Economics at Duke and a founding member of the Center for Advanced Hindsight. Dan’s books, Predictably Irrational, The Upside of Irrationality, The Honest Truth About Dishonesty, are NY Times best sellers. Dan also has a podcast “Arming the Donkeys”. A new book by Dan and Jeff Kreisler is expected to go on sale November 11 2017 titled Dollars and Sense.