Picture this. You want to replace the stabiliser for your air conditioner. A store near your house retails the product for Rs 3,500. You can get the same product from a store in the neighbouring locality for Rs 2,750 and, thus, save Rs 750 or around 20 per cent. Will you travel to the neighbouring locality to buy the cheaper product?

If you are a typical individual, chances are you will buy the cheaper product. As humans, we like bargains. But here is the problem. Suppose you are buying an air conditioner and a stabiliser, the store near your house charges Rs 40,000 whereas a store in the neighbouring locality offers the same for Rs 39,250. Will you now drive to the neighbouring locality to buy the cheaper product?

You will most likely rationalise that saving less than 2 per cent on the air conditioner may not be worth the ride in traffic. Your behaviour would seem illogical to economists. The money that you save is money that you can use for your household expenses. How does it matter whether you save Rs 750 buying only the stabiliser or both the air conditioner and the stabiliser? The problem is that we do not think in absolute terms. We compare savings of 20 per cent with savings of 2 per cent. This behaviour can lead us to make systematic errors.

Investment decision

Consider your investment decisions. You may save significantly on your grocery purchases — 5 to 10 per cent — if you visit a discount store. The fees on your mutual fund investments, however, are only marginally different even if you shop around — one per cent versus 2.5 per cent. That is, typical index fund charges you one per cent on your investment whereas typical active fund charges you 2.5 per cent. So you may not pay as much attention to your mutual fund fees as you would towards your grocery purchases. But have you analysed how much money you can save and invest by reducing your investment costs?

Further, it is surprising that many individuals have not used the direct route to investing in mutual funds. If you buy a mutual fund directly from an asset management firm, you will incur lower charges than if you buy the units through a distributor. Suppose the direct route saves you 0.50 per cent on an investment of, say, Rs 10 lakh every year, you save Rs 5,000, which can be invested. For an investment period of 10-15 years, this savings could accumulate to a large amount, perhaps, much better than the savings you can make on your regular grocery purchases.

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

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