1) Imagine that six months from now, you are planning to purchase a new washer and dryer. The two machines together will cost $1,800. You have two options for financing the washer and dryer at a zero interest rate. Which option would you choose?
A) Six monthly payments of $300 each during the six months before the washer and dryer arrive.
B) Six monthly payments of $300 each during the six months beginning after the washer and dryer arrive.
2) Imagine that you are planning to take a one-week vacation to the Caribbean six months from now. The vacation will cost $1,800. You have two options for financing the vacation at a zero interest rate. Which option would you choose?
A) Six monthly payments of $300 each during the six months before the vacation.
B) Six monthly payments of $300 each during the six months beginning after you return.
Note that the total cost is the same in all options; only the timing of the costs is different. In question #1, 84% of those surveyed preferred choice “B,” the postponed payment. After all, the benefits of the washer and dryer will be used for years after their purchase. Thus, paying the cost over a concurrent period matches the cost to the benefit. Option “B” is also consistent with rational economic theories; that is, people should choose “B” because it is less expensive after considering the time value of money.
In question #2, 60% of respondents selected option “A,” the prepaid vacation. In this case, the payment options do not match with the consumption of the goods. The benefits of the vacation are consumed during the vacation, but the vacation must be paid for either before or afterward. Traditional economic theories predict that people will prefer option “B” because it is cheaper after considering the time value of money. However, most people choose option “A.” Why?
Most people believe that a prepaid vacation is more pleasurable than one that must be paid for later because the pain of payment is over. If payment is to be made later, the benefits of the vacation are diminished by wondering how much the pleasure is going to cost. You see, the thought of paying for an item over the time that item is being used reduces that pleasure of using that item.
People, in general, express an aversion to debt when the good or service is consumed quickly. Using debt to purchase homes, and cars (and washers and dryers) is popular because these items are consumed over many years. On the other hand, people do not like to make payments on a debt for a purchase that has already been consumed.
This is the exact problem that most investors experience when trading on margin. You see, many aggressive investors tend to trade stocks and options on margin, as a way to have access to more money and thus increase their purchasing power. This is a fine strategy to use, until you incur losses or it’s time for the dreaded maintenance or margin call. In times of market uncertainty, your portfolio will likely experience some downsizing as the stocks you are holding are now worth less than when you purchased them.
When this happens, many investors then have to sell their existing positions they bought on margin for a loss, forcing them to either liquidate some of their individual holdings or transfer more cash to their account in order to cover losses. Trading on margin account often feels like “free money” when you are making gains, but the trouble starts when you begin to incur losses. The action of paying back money for losses incurred in a margin account can often drive investors out of the stock market, as this money is no longer “free,” and the burn starts to set in.
The Gorilla has heard hundreds of stories of poor investing habits spiraling out of control, and eventually wiping out the vast majority or one’s entire portfolio. Whether or not you have ever exhibited the behavior detailed above, it is simple to see how a structured, risk-controlled system can help investors to make better decisions with their money. Often, even seasoned investors let their emotions cloud their sound judgment, and end up making the wrong decision; which can be very costly.
The key to investing is removing emotions from the equation and avoiding the behavior detailed above. And, the key to growing any portfolio is simply to ride the winners and cut your losses while they are still small. GorillaTrades takes the guesswork out of investing by telling you which stocks have the highest potential for capital appreciation, and then clearly explains exactly when to enter into a specific position, and when to exit. With the Gorilla’s market advice, you can easily navigate through this “jungle” of a stock market as the Gorilla simplifies investing by identifying and holding the winners, and quickly cutting the losers.