Lets assume a group of students appearing for exams.
There are three basic groups of students in exams: those who mastered the syllabus (Grade A), those who grasped the basic concepts (Grade B), and those who just did not understand it (Grade C). Those above 70 marks will get A, marks between 50 to 70 will get B and marks less than 50 will get C. In a hard examination situation, the average score of the students was 72 out of 100. Despite having generous grading system, the students were unhappy with their results and the dissatisfaction was escalated.
Hence the professor came up with a solution to make the exams out of 137 marks instead of 100 marks. This made the average score of 72 to 96, and the students were happier, even though their actual grades were not affected. There were two outcomes. First, it produced an average score well into the 90s, with some students even getting scores above 100, generating a reaction extra delight. Second, because dividing one’s score by 137 was not easy to do in one’s head, most students did not seem to bother to convert their scores into percentages.
The professor reflects on this experience and concludes that his students were “misbehaving” in the sense that their behaviour was inconsistent with the idealized model of behaviour used in economic theory.
Here is how we relate it to Investments.
In investment behavior class, investors are often unhappy with their current investment returns. In some instances, investors tend to transact even more in expectation to increase the returns. But resultant remains the same. The core behavior theory is that investor choose to optimize and make choices based on rational expectations. In this zest, they ‘misbehave’ with their investments.
Investors also come in sweet talk with number crunching just like the professor did. Financial Salesmen are often in search of opportunities to dump their financial products by committing fixed returns, assuring fixed cash flow or guaranteed NAV products. Unfortunately, it is sometimes not easy for investors to understand the numerical gimmicks of such salesmen.
At Shalibhadra, we avoid numerical gimmicks and set the expectations only at right place which is realistic and achievable.
Nishit Siddharth Shah