The Rational Investor #026: Rory Sutherland on Market Prices & Behavior
Happy Saturday to you,
Welcome to the 26th edition of The Rational Investor Newsletter.
Before I begin this week’s newsletter, I want to apologize for my absence for the last month or so. My world was briefly turned upside down, so I decided to temporarily pause all non-essential activities. I appreciate your patience and kind emails and am excited to get back to sending this on a weekly cadence once again. :)
This week’s quote comes from my favorite marketing book which is, Alchemy, by Rory Sutherland. Because of its heavy focus on psychology, I find this book to be as rich in investing insights as it is in marketing wisdom. It’s honestly one of my favorite books from the last few years and is one I refer back to often.
The only change made to today’s quote is to break up the paragraphs for easier readability.
Onto the main event…[italics are of the author]
Here’s Rory Sutherland on Market Prices & Behavior:
The following is a perfect illustration of the tendency of modern business to pretend that economics is true, even when it isn’t. London’s West End theatres often send out emails to people who have attended their productions in the past, to encourage them to book tickets, and it was the job of an acquaintance of mind who worked as a marketing executive for a theatre company to send out these emails.
Over time, she learned something that defied conventional economic rules; it seemed that if you sent out an email promoting a play or musical, you sold fewer tickets if you included an offer for reduced-price tickets with the email. Conversely, offering tickets at the full price seemed to increase demand.
According to economic theory, this makes no sense at all, but in the real world it is perfectly plausible. After all, any theatre selling tickets at a discount clearly has plenty to spare, and from this it might be reasonable to infer that the entertainment on offer isn’t all that good.
…
Despite my friend’s discovery, her colleagues continued to demand that she discount tickets. She patiently explained to them that any discount would reduce the demand, so they would end up selling fewer tickets at a lower price, but they would insist that she include the discount anyway.
They persisted in acting this way because, even though it was epirically the wrong thing to do, in economic terms it sounded logical. If 30 percent of the seats failed to sell at a discounted price, it was assumed that they would not have sold at a higher price. If, by contrast, she hadn’t offered a discount and 20 percent of the seats had not sold, she could have been blamed.
People’s motivations are not always well-aligned with the interests of a business: the best decision to make is to persue rational self-justification, not profit. No one was ever fired for pretending economics was true.
I think there are two takeaways here: one for practicing financial advisors and one for investors.
For financial advisors (or anyone in business), my hope is that you see the folly in discounting your own fees when taking on a new client. The less you believe in the value of your services (which is what you may be implying when you discount your fees), the less your prospective client will believe in the value of your services. You may think that discounting your fees makes you more desirable, but it may actually undermine your business.
As for investors, this explains why people are often more willing to buy stocks when prices are high and rising rather than falling. Despite the fact that value has an inverse relationship with prices, people psychologically tend to believe that declining prices are an indication of declining value, which is the opposite of truth in real economic terms.
If our goal is to be as rational as possible, as Charlie Munger recommends, then we would be wise to remember that falling prices are opportunities to buy more shares of great companies at temporarily discounted prices.
Thanks for reading. I’ll be back again next week with more timeless wisdom from great investors.
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