A penny or $0.01 for your thoughts

By Warren Boroson
(Morristown, N.J.) Daily Record

Are you a normal, average, garden variety investor? In other words, are you — like most investors — just a little bit nuts?

All the questions below come from experiments described in the book "Investment Madness: How Psychology Affects Your Investing ... and What You Can do About It," by John R. Nofsinger (Prentice-Hall, 2001).

There are no right or wrong answers. In fact, let me assure you that on this test you will get 100 percent — a perfect score. The only thing we are checking is whether your answers jibe with the answers given by most people.

Questions

1. Would you rather receive (a) $50 right now or (b) $100 in two years?

2. A few years ago, you bought a stock for $50 a share. At the end of last year, you made a note that the price was $100 a share. Last week, you sold the stock for $75 a share. Do you feel (a) good or (b) bad?

3. Let's say you bought two stocks, each for $100. One was a biotech stock, one was a pharmaceutical. The following year, the biotech stock gradually fell to $75 a share. The pharmaceutical stock remained at $100 a share — until the end of the year, when it suddenly plunged to $80. Which stock would you be more likely to sell, (a) the biotech stock or (b) the pharmaceutical stock?

4. You have tickets to a New York Giants football game. The day of the big contest, there's a raging snowstorm. Are you more likely to skip the game if you got the tickets free rather than if you paid $50 apiece for them?

5. You've just lost a ton of money on some stocks. Would you invest in more risky stocks now, to try to recover your losses?

6. Someone wants you to gamble. He will flip a coin, and if it's heads, you win $10. If it's tails, you lose $10. Are you LESS likely to bet if the coin has already been flipped — and the coin's face concealed, so no one knows whether it's heads or tails?

7. You have been playing the lottery, choosing the number 212121. Month after month, you have been losing. Someone suggests that you change numbers. So you switch to 123456. If 212121 wins now, would you feel terrible? What if you didn't switch, and 123456 won? Wouldn't you also feel terrible? In which situation would you feel MORE terrible?

Answers

1. Most people would prefer (a) receiving $50 right now — even though receiving $100 in two years would bless you with you a stupendous 41 percent compounded yearly return. Most people focus on the short-term.

2. Many people would feel sad, using the more recent reference point ($100 a share) rather than the older purchase price ($50). In fact, some investors wouldn't even sell at $75 just because of the pain they might feel for NOT having sold for $100.

3. Most people would sell the pharmaceutical stock, although its loss was less than that of the biotech stock because its loss was not so dramatic and recent as the loss on the pharmaceutical stock. Likewise, if the biotech stock had slowly risen to $125 while the pharmaceutical stock at the last minute soared from $100 to $120, they would probably be more optimistic about the pharmaceutical stock — because its gain was more recent and dramatic.

4. Yes. This is called the "sunk-cost effect." If you have put money, or time, or effort into any activity, you're more likely to continue. People who have spent money on repairing a car will be more likely to spend more money if the car still has problems. People who have lost money on a stock or mutual fund may put more money in, hoping to recover their losses.

5. Many people would. At horse races, "The (percentage) of money bet on long shots is greater toward the end of the race day than at the beginning of the day," reports Nofsinger.

Gamblers with wins are also more likely to bet on long shots at the end of the day because they figure that they are betting with "house money." And many investors who have either made or lost a lot of money recently are more inclined to invest aggressively.

6. Most people are less likely to bet if the coin has already been flipped. One explanation: People harbor the delusion that they can influence the outcome of pure gambling events. (Another explanation: Such a contest is less exciting than one in real time.)

7. Most people would feel worse if their original choice won. The "regret of commission" is more painful than the "regret of omission." This helps explain why investors so tenaciously hold onto their losing stocks.