Have you ever wonder why, when it comes to money, we get so emotional? People do crazy things for money. Wall street is always full of controversies, so it seems. property investors are blamed for being greedy and caused “bubble” in the property price.
I like to read. So when I was staying at Quest apartment in Rotorua, I flipped through its magazine and there’s one article which intrigued me and I think it’s very appropriate to share a small part of it with you here. It’s not very short, but read it and the next time you come across a decision that will impact your financial life, this will remind you to make the right decision.
Subject: Riding the waves of IRRATIONAL economics
“Why do people panic when the property market starts soaring and despite higher prices and greater personal financial risk, rush out and buy? Normally you would expect us to buy less when prices rise and more when they fall.
There is a growing movement in economics that is challenging some of the basic assumptions about our supposedly rational behaviour. Called behavoural economics or socio-economics, the asumtpion of rationality is thrown aside.
Take some simple examples:
You wish to buy a ball-point pen but the shop you enter is charging $10. You know you can get the same pen in the next block for $1. Most people would walk down the block. But if it came to buying a new car and the difference in price was $9, most people wouldn’t walk across the street. The economic decision is the same – a potential saving of $9.
Most investors are also loss averse. A $1000 loss on an investment hurts more than a $1000 gain gives pleasure. For this reason many investors refuse to sell an asset because it crystallises a loss even if it could mean the loss getting larger or they could reinvest the proceeds and make a gain elsewhere.
Another take on our irrationality comes from those who believe in the Elliot Wave theory. Developed by Ralph Nelson ELliott, the Wave Theory postulates that markets swing in huge cycles and that these cycles are driven by the emotional mood of the population. The mood can be optimisitc or pessimistic and can override our rational judgements. Thus when we are optimistic, we buy shares and houses and the price does not seem to matter much. If anything, the more the price rises, the more attractive the asset. When we are pessimistic, we do not buy even if prices have fallen sharply. Prices stay low until, well, people get sick of being depressed. Then they start to buy and the cycle starts again.
Proponents of this idea, such as US economist Robert Prechter, say these moods only seem to affect asset markets such as shares and property. When it comes to bread and butter issues such as groceries and consumables, we are much more rational. If the price of these everyday products drops, we tend ot buy more.
Why the difference? Apparently the reason is that asset markets are uncertain and difficult to judge rationally. As a result, a herding instinct comes to dominate our rational thinking. It is deemed too dangerous to be out on our own so we do what everyone else is doing.”
Robert Kiyosaki, in one of his books, tells us a lesson that is closely related to this subject. Rich dad told the young Robert that both him and his poor dad are doing the same thing, but from a different mindset. Robert asked what Rich Dad meant by that. Rich dad asked Robert what his parents spend most of their time on, when not at work. Robert told him that his family spent a lot of time going to different groceries stores and supermerkets buying foods and grocery items. His parents said they could save a lot of money this way. Everytime there’s a sales, his poor dad would buy as many of the sales item as they could. Once there’s a special sales on hamburger patties, his dad bought home so many hamburgers and kept them in the freezer that the family could eat them for months. Rich dad chuckles when he heard about the hamburger story. And after a slight pause, he began telling Robert that he also does the same thing when there are “sales”. But with the mindset of the rich, he does not buy groceries from supermarkets at a discounted price to keep them in a freezer like the poor dad. Instead, he buys shares through his broker when the market has crashed, or buy Real Estate when the yields are high, and keep them in his investment portfolios. I hope the stories above will help you with your financial decision.
All the best,
Chayot Ing-aram
PS Congratulations to Tina Chen for your success and thank you for sharing your story with the reader of the latest NZ property Investor Magazine (Cover story: $2.5 million portfolio at age 24).
