- Where our perception of value comes from
- How perception of value drives market movement
- What subconsciously influences your perception of value
What makes someone refuse to spend more than $2.99 on a ½ pint of raspberries but pushes that same person to buy the latest iPhone for over $1,000?
It’s the same thing driving the stock market and our entire economy.
Perceived value, or our perception of value, is the idea that the value or worth of a product or service depends on the individual purchasing it. Simply put, what something is worth differs from person to person. You’re willing to buy things you perceive as valuable while avoiding things you don’t see the value in. This seems intuitive. But this force drives more than our everyday purchases, it's the engine behind the entire stock market.
When it comes to investing, the value of an investment depends on how you perceive it.
Where our perception of value comes from
Each of us put a different value on everything in our lives. But why? Why do we look at the same thing (for instance, a bicycle) but one person is willing to pay $150 while another would spend $250? It’s the exact same bike, but the value is subjective.
This subjectivity is based on four factors:
- Scarcity: How rare the object is. Also known as the law of supply and demand. The lower the supply, the higher the demand and more you can charge for the item.
- Passion/personal attachment: You have an attachment to an object that other people do not. Like a watch given to you by your grandfather. There is an inherent sentimental value.
- The potential for profit: You think the object will rise in value and then you can turn around and sell it for a profit.
- The person’s current situation: You have a dire immediate need for it. Like someone wandering the desert desires a glass of water.
People don’t buy products because of the actual value of the products – they buy stuff because the price of the product closely matches their perceived value of the product-Charlie Gilkey
While these factors come into account almost every time you buy something, each one doesn’t affect every purchase. For example, just because you think the value of a bottle of wine will raise in 10 years, doesn’t also give it a sentimental value.
How the perception of value drives market movement
Markets wouldn’t exist without our perception of value. When you buy a stock for $25, you see value in the stock at that price. Whereas the person on the other side, who is selling the stock, sees value at getting rid of it at $25.
What adds to this magic of the market is there isn't a standard way to determine how much a stock is worth. This creates the discrepancy of the market and allows it to work.
While there isn’t one way to value stocks, a popular method is by analyzing a company's fundamentals.
Fundamentals include news and performance of the company, as well as how the industry is performing. Economic factors (like inflation, interest rates and current political events) also influence a company’s stock price. By researching fundamentals, you can decide what a company should be worth and if the stock price reflects your value. This type of investment strategy is also known as value investing.
Warren Buffett is the king of value investing. He chooses stocks based on their overall potential as a company. When Buffett invests in a company, he isn't concerned with whether the market will eventually recognize its worth. He focuses on how well the company can make money as a business over the long term. He acknowledges people’s perception of value will be different from his own and looks for advantages in the market based on these perceptions. For more on Buffett’s approach to investing read our blog, What Buffett and the Terminator can teach you about investing
There is no truth. There is only perception.-Gustave Flaubert
Buffet has an acute awareness of the perception of value and the biases affecting it. Let’s look at some of these biases and how it can influence your perception.
What subconsciously influences your perception?
Now we know everyone values things differently and how we arrive at that value. We can be more aware of some of our own biases subconsciously affecting the value we give things.
Biases are nothing new to investing. You always know someone who has this “hot tip” or the “best way to invest.” Same way everyone has “the best [insert phrase here],” there are several biases affecting how we invest.
- Overconfidence bias: the tendency people have to be more confident in their own abilities, such as driving, than is objectively reasonable. You may have more confidence in your investment ability (especially when the market is in a hot bull market) than you can realistically have.
- Endowment Bias: the hypothesis that people ascribe more value to things merely because they own them. When you own a stock, you may believe it’s worth more simply because you own it.
- Loss Aversion bias: people's tendency to prefer avoiding losses than acquiring equivalent gains. You may hold on to a losing stock, waiting for it to rebound when the company is in dire financial trouble, just to avoid realizing the loss.
- Anchoring bias: a term used in psychology to describe the common human tendency to rely too heavily, or "anchor," on one trait or piece of information when making decisions. You may see a company is doing really well in one division but not realize that division of the company has a small impact to the bottom line.
For a deep dive into these biases, how to beat them and more, read our blog, Is your cat a better investor than you?
Now that you’re aware of the perception of value and how it can affect the way you invest, you can learn to avoid it and even use it to your advantage. Usually your perception of value is influenced emotionally. When evaluating an investment, or any purchase in life, try to look at the opportunity objectively. That way, the value you place on something will more closely match the reality.
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The information in this blog is for information purposes only and should not be used or construed as financial or investment advice by any individual. Information obtained from third parties is believed to be reliable, but no representations or warranty, expressed or implied is made by Questrade, Inc., its affiliates or any other person to its accuracy.