This is the tendency of humans to make decisions based on faulty comparisons can lead to bad results
15-Sep-2015 •Mohammed Ekramul Haque
What is it? This is the tendency of humans to make bad decisions based on faulty comparisons. The term 'contrast' means to compare to see differences between two or more products or services.
A husband who marries for the second time will often compare his new wife with his first wife. That comparison is incorrect. Moreover, if the husband bases any decisions on this comparison, it could have disastrous results on his existing marriage.
Often found in: Decisions based on two or more alternatives.
In Life: Munger explains how real estate agents misuse this tendency. "A particularly reprehensible form of sales practice occurs in the offices of some real estate brokers. A buyer from out of the city, perhaps needing to shift his family there, visits the office with little time available. The salesman deliberately shows the customer three awful houses at ridiculously high prices. Then he shows him a merely bad house at a price only moderately too high. And, boom, the broker often makes an easy sale."
In corporations: The contrast- misreaction tendency is used by conniving corporations to make the illusion that products on offer give a good deal to the customer. This is, however, far from the truth. In a very recent example, Flipkart, one of the country's leading online retailers was found to quote an inflated MRP of `799 for a pair of wedges (sandals). The retailer subsequently offered a 50 per cent discount, pricing the sandal at `399. A close inspection of the photo reveals that the sandal has a printed MRP of `399, making the effective discount zero. But unsuspecting customers could get away thinking that they got a good deal. The power of the contrast-misreaction tendency comes into play when even after knowing of such manipulative practices, customers still flock to buy.
In investing: The Bata India stock is down close to 40 per cent from its 52-week highs. Does that make the stock an attractive buy? Or take Nestle India. After the Maggi debacle, the stock which was once available at `7,500 is now at `6,000. Is it attractive now? The answer to both of the above questions would be: not necessarily. Price comparisons based on past performance are not the correct measure of attractiveness or otherwise of a stock you are looking at. One should look at the current scenario and try to draw future prospects therefrom.
You just read about one of the misjudgements people generally make while investing. Read 25 ways to (Not) make mistakes to get an account of Charlie Munger's twenty-five typical misjudgements, along with our commentary on how they fit into Indian businesses and Indian investments.