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Stocks to Riches

Decision Paralysis And Endowment Effect

The chapter starts with the status quo bias or the decision paralysis bias. Investors generally face this when they need to sell their loss-making holdings. It is not easy to take such bold moves. The author has given a solution to this under the book’s section, “Taking Decisions”. Parikh states that people don’t take decisions for any one of the following reasons:

 

  • Fear of going wrong
  • The possibility of losing
  • To avoid looking foolish
  • Unwilling to take risk

Some of the behavioral biases like, loss aversion, regret aversion, and egoistic human nature can play a role in delayed decision making.

 

Similarly, endowment bias comes into play when you refuse to sell something even at a fair price just because you envisage that because the product/stock belongs to you, it’s very valuable. You might not purchase the same product/stock at the price you are quoting. This is called the endowment bias.

 

The trial and money-back guarantee scheme, something like this, also plays on customers' minds and is an Endowment bias.

 

Once you get the product home, there is an emotional attachment which increases its perceived value and it's difficult for you to let it go.

 

Let's now look at some of the remedies suggested by the author- 

 

  • Deciding not to decide is also a decision. It is not always necessary to take a buy call on a stock, there is also an option to leave it aside for a while.
  • Consider opportunity cost. Whenever you delay a decision in investing, do consider the opportunity lost during that time. The author does not mean that waiting for a stock to fall in order to buy it at the right price is the wrong decision. However, do keep in mind the loss of interest or opportunity during the waiting period. 
  • Put yourself on autopilot mode. Here the author suggests fixing SIPs and not falling into the trap of timing the market at all. This mechanical way shrugs off the decision paralysis.
  • Don't get married to your stock. Remember, you buy stocks for the purpose of beating the market returns. However, if the stock has reached its full potential, take a rational decision and make a switch.
  • No free lunches. Like in life, in stock markets, too, everything comes at a price. The offering of free investor conferences and flashy AGMs to attract investors via the endowment effect needs to be understood. Remember, when a product is offered to you for free (recall the trial period offered on Amazon Prime and Netflix), you are the product.

The next chapter deals with mental accounting.

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Units 7/13