Young Investor

Ill-effects of inaction

B.Venkatesh | Updated on July 09, 2011

Would you buy a pair of shoes if the discount dropped?



Consider this. A branded pair of shoes that you want to buy typically retails for Rs 5,000. A certain store offers the pair at a 25 per cent discount. You decide not to buy them, as you expect the shoes to go on sale at a 40 per cent discount. A few days later, the store rolls-back the price to a 10 per cent discount. Will you buy the shoes, considering that you missed the opportunity to buy them at a 25 per cent discount?

Typical behaviour indicates that you will pass the 10 per cent discount sale. This is because you are likely to be disturbed by the fact that you missed the opportunity to buy the shoes at a 25 per cent discount. The feeling of regret could be so immense that you will also pass the 10 per cent discount sale, as it is inferior to the earlier sale. This, despite the fact that the 10 per cent discount is better than paying full price. Behavioural psychologists call this “inaction inertia”. It refers to our inaction to avoid possible regret.

Inaction inertia

We display similar behaviour in the stock market as well. Suppose you buy a stock at Rs 100. It rises to Rs 125 after a while but you do not sell, as you expect the price to move to Rs 140. Unfortunately, the stock declines to Rs 80. Would you sell or hold the stock? If you suffer from inaction inertia, chances are you will hold the stock. Because you missed the opportunity to sell the shares at Rs 125, you would most likely pass the chance of selling it at Rs 80, even though cutting losses at this price may be worthwhile.

Classical economics tells us that we should buy the shoes, as a 10 per cent discount is better than none. Likewise, selling the stock at 20 per cent loss could be better if the price is expected to decline further. Yet, research has shown that we tend to pass such opportunities, driven by the feeling of regret of having failed to act sooner.

(The author is the founder of Navera Consulting. He can be reached at >enhancek@gmail.com

Published on July 09, 2011

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