What return is reasonable

B. Venkatesh | Updated on August 03, 2013 Published on August 03, 2013

Parting with your house typically causes pain which drives you to demand apremium when selling it.

Your sense of what is reasonable depends on whether you’re a buyer or a seller

Picture this. You are yet to sell the land that you bought 10 years ago because you are unable to find a buyer at a price that you think is reasonable. At the same time, you want to buy an apartment, but are unable to find one that you like at a reasonable price. Is there a problem with how reasonable you are? Or is life just unfair to you?

The problem is that your sense of what is reasonable changes depending on whether you are a buyer or a seller. And what’s more, your ‘reasonable’ price for the same product will be different depending on whether you a buyer or a seller.

Suppose you want to buy a 1,000 sq ft apartment. You may believe that a reasonable price for such an apartment in a certain neighbourhood is Rs 85 lakh. But if you already own such an apartment, you would most likely want Rs 1 crore if you were to sell it.

It turns out that behavioural psychology has an answer to your ‘reasonable’ price issue. And it is this: Parting with things you own typically causes pain. Look at your wardrobe and you are certain to find clothes that do not fit you anymore. Yet, you find it difficult to part with them. Of course, you can be coerced into parting with your clothes. Or you would buy new clothes, and the excitement of having a new wardrobe can motivate you to part with some older ones. This is, however, not the typical case with your investments.

Parting with your land, apartment or stocks essentially means selling the asset for a reasonable price. But the pain of parting is likely to drive you to demand a pain-premium. In the example above, it was Rs 15 lakh — the difference in the selling and the buying price of the apartment. In the case of stocks, the pain-premium refers to the price that you demand above the current market price. So, if a stock trades at Rs 500, you may want more than Rs 500 to sell your shares. The pain-premium is one reason why you tend to make limit-orders when you are buying or selling shares.

Costly consequences

The pain-premium can sometimes have costly consequences on your finances. When your price is unreasonable to potential buyers, you may be unable to sell your investments before they decline in value. And because you cannot make yourself sell your investments at a loss, you will end up owning your assets for a longer period, so long that you could sometimes unintentionally transfer your investments to your children after your lifetime.

(The author is the founder of Navera Consulting. Feedback may be sent to >knowledge@thehindu.co.in)

Published on August 03, 2013
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