Pete Wargent blogspot

Co-founder & CEO of AllenWargent property advisory, offices in Brisbane (Riverside) & Sydney (Martin Place) - clients include hedge funds, resi funds, & private investors.

4 x finance/investment author - 'Get a Financial Grip: a simple plan for financial freedom’ (2012) rated Top 10 finance books by Money Magazine & Dymocks.

"Unfortunately so much commentary is self-serving or sensationalist. Pete Wargent shines through with his clear, sober & dispassionate analysis of the housing market, which is so valuable. Pete drills into the facts & unlocks the details that others gloss over in their rush to get a headline. On housing Pete is a must read, must follow - he is one of the better property analysts in Australia" - Stephen Koukoulas, MD of Market Economics, former Senior Economics Adviser to Prime Minister Gillard.

"Pete Wargent is one of Australia's brightest financial minds - a must-follow for articulate, accurate & in-depth analysis." - David Scutt, Business Insider, leading Australian market analyst.

"I've been investing for over 40 years & read nearly every investment book ever written yet I still learned new concepts in his books. Pete Wargent is one of Australia's finest young financial commentators." - Michael Yardney, Australia's leading property expert, Amazon #1 best-selling author.

"The most knowledgeable person on Aussie real estate markets - Pete's work is great, loads of good data and charts, the most comprehensive analyst I follow in Australia. If you follow Australia, follow Pete Wargent" - Jonathan Tepper, Variant Perception, Global Macroeconomic Research, and author of the New York Times bestsellers 'End Game' and 'Code Red'.

"Pete's daily analysis is unputdownable" - Dr. Chris Caton, Chief Economist, BT Financial.

Invest in Sydney/Brisbane property markets, or for media/public speaking requests, email pete@allenwargent.com

Friday, 20 September 2013

Predictable Irrationality: Part 1 - Relativity

In his 2008 book Predictably Irrational, Dan Ariely presented a fairly compelling case which argued that although humans are irrational beings, our decision making-processes tend to be systematic and therefore could to some extent be predictable.

Ariely identified a number of traits and areas of our lives in which he argues that we are predictably irrational, and explains a number of familiar behavioural traits, including why we overvalue what we have (anyone who has ever gone through the process of selling a home may be familiar with this trait!) and why dealing in cash can make us more honest.

Relativity

One key area that we would do well to be aware of and better understand is how the brain works with relation to relativity and decision-making. Of course, that we tend to compare choices and alternatives is not a ground-breaking concept in itself, but we need to understand that our decision-making can be wildly skewed by the range of alternatives on offer.

It's actually the way our brains our wired: we compare one job with another, we compare last year's holiday with this year's holiday, we compare one brand of beer with its competitor, and so on. We rarely have a keen grasp of absolute value or quality, but once we have the context of something to make a comparison with, we feel more able to make decisions. 

For example, I read somewhere once (no, seriously, I've never done it!) that speed-daters raise or lower their expectations of a potential partner's looks depending upon the 'quality' of the field.

Ariely puts is like this: "Most people don't know what they want unless they see it in context."



Framing

Take the example of business magazines and newspapers: such publications are shifting towards digital media anticipating growing demand for that format. They might offer subscriptions in the following manner:

-Option 1 - Website subscription $200pa
-Option 2 - Print subscription $300pa
-Option 3 - Print and website combined subscription $300pa

Offers like this are not framed in such a manner accidentally. The publishers fully expect a handful of penny-wise buyers to go for Option 1, none at all to choose the seemingly unattractive Option 2, and the overwhelming majority to select the 'bargain' of Option 3. 

And here's the key point, says Ariely - we don't choose things in absolute terms and often have little idea of what an investment or consumer goods may be worth. Instead we function by comparing them with readily available alternatives in order to make decisions. Buyers of televisions, for example, often have little idea of what a TV should be worth, so they go for the 'reasonable' middle option (I often seem to do this kind of thing).

The absolute masters of framing deals are vehicle financing divisions in the large automobile groups. Famously car-manufacturing giants in the US frequently made more from financing car deals than they did from their core business sale of vehicles; in effect they became lenders who happened to manufacture vehicles. Car financiers understand better than perhaps anyone else how to frame a deal or an offer so that the buyer focuses on the affordability of the monthly cash-flow rather than the extortionate total repayment amount.

Investing

I could drone on with a plethora of other examples, but the key point for investors to understand is how our bias towards relativity impacts our decision-making. 

Clearly in the share markets we are constantly weighing up whether one stock represents better value than another - we only have so much available capital, so we have to make a choice. But should we rather be sometimes focussing on whether the market as a whole offers value? If we are comparing a stock with a PE ratio of 25 as compared to one trading at 30 times earnings, we might think it offers comparatively 'better value'...but still it might represent a poor investment.

Skilled car salesmen know in which order to show likely buyers their possible selections in order to get them 'over the line' to purchase, so do you think a skilled real estate agent might think the same way? I would say so. Buyers in today's property markets where auction clearance rates are high and prices are moving upwards need to be wary of comparing two properties and deeming one to be better value than another...and thus necessarily a 'good buy'.

The reality is that skilled property investors and professional buyers agents usually have a list of key criteria which they look for in an ideal investment, but often not every box can be ticked due to budget constraints. Thus you might be left with a choice between properties of an equivalent asking price where one has, say, a lift and slightly higher strata fees, but another is lacking in natural light and is south-facing. You might have to make a compromise on one or two of your desirable characteristics, but it remains vital not to overpay in a hot market.

It is important to be mindful of how you frame these questions and also consider whether there are some characteristics of properties which are deal-breakers - such as very noisy streets or being located too far from transport or employment hubs, or entertainment. 

More than anything else, do not be deceived into thinking that just because one property appears to be better than another that it must therefore be a sound selection, for this is by no means necessarily true. This is especially the case in the major capitals where the weighting of auction sales is higher than elsewhere - be very wary about becoming involved in frenzied bidding wars.

A final thought

The way we use relativity to make decisions can even impact our emotions. Can we decide to feel sad because we have less than someone else? Absolutely we can, and people exactly that all the time - envy and jealousy spring directly from relativity and from comparing ourselves with the lot of our neighbours or peers.

Australians would do well to consider that rather than being unfortunate, as compared to most of the world, even the 'bushies and the battlers' are often among the most fortunate. We should all try to move away from the idea that we never have enough and learn the character traits of some of the world's poorer citizens where people are often appear more content with their lives despite 'having less'.

A couple of decades back, there was a shift in disclosure requirements in company Annual Reports (sorry, I'm an accountant...can't help it) which required listed corporates to include in Remuneration Reports a large amount of previously unrequired detail relating to the remuneration and benefits of CEOs. So the theory went, by making all of this information public, companies would no longer be able to abuse shareholder trust by paying their CEOs excessive or obscene packages. 

In theory then, CEO remuneration should have fallen, right? Wrong. Of course, what actually happened is that CEOs began to compare enviously their pay packets with other better paid CEOs and remuneration levels soared as they competed for ever-higher pay deals. A Porsche was never going to be enough when the next guy was driving a Ferrari.

Relativity can be useful in decision-making when it used to our advantage, but it can also be destructive unless we can learn to break the cycle of always wanting more.

I'll sign off today with a famous quote from Albert Einstein who developed the theory of relativity in physics: "When you are courting a nice girl an hour seems like a second. When you sit on a red-hot cinder a second seems like an hour. That's relativity."