You will review three past decisions to find the reference point behind each and test a better one.
You now have names for three patterns: reference points, loss aversion and the endowment effect. Knowing the names is the easy part. The harder part is catching them in your own decisions, where they never announce themselves. A choice driven by a reference point feels like common sense at the time. This exercise goes back through your log from lesson 1.4 and makes the reference point behind three decisions visible, then tests what happens if you swap it for a better one.
Pick three entries from your log that involved a sale, a purchase or a risk you took or turned down. The best candidates are ones where you remember feeling that you'd won or lost something. Good examples include selling or holding an investment, negotiating a salary or a price, cancelling or keeping a policy or plan, and deciding whether to take a job, a loan or a bet.
If your log doesn't have three, add older decisions from memory. A decision from two years ago is fine, as long as you can recall roughly what you were thinking.
For each decision, write the number or situation you were measuring against. Then write how the outcome felt against it, as a gain or a loss.
This is harder than it sounds, because reference points are usually unspoken. A few prompts help. What number did you keep thinking about? What would have counted as "breaking even"? Who or what were you comparing yourself with? What did you expect before it happened?
Now pick a reference point that fits your goals rather than your history. Lesson 2.1 suggested some: today's value and your plan for an investment, the market rate and your budget for a salary, and the amount you'd planned around for a bonus. For anything you own, the test from lesson 2.4 works: would I buy this today, at today's price?
Then write how the decision looks against the new reference point. Sometimes it changes nothing, and the original choice holds up. That's a useful result too. Sometimes it changes everything.
Finally, mark any decision where the wish to avoid a visible loss, or attachment to something you already owned, seems to have played a part. A simple "LA" for loss aversion or "EE" for the endowment effect in the margin is enough. These tags will feed into your trade audit in lesson 6.6 and your playbook in lesson 8.4.
Here is Hui Min's review.
Her first decision was holding the SGX shares she bought at S$2.40. The reference point she used was the purchase price, S$4,800 for 2,000 shares. Against it, today's S$4,200 felt like a S$600 loss, so she kept holding to get back to even. Her better reference point is S$4,200 in cash and her target allocation. Against that, the question becomes whether these shares deserve S$4,200 of her money today. She decided they deserve about half that, and plans to sell 1,000 shares. She tagged it LA.
Her second decision was a job offer she turned down last year at S$6,200 a month. Her reference point was a friend in a similar role earning S$6,800, so the offer felt like a S$600 insult. Her better reference point is her current pay of S$5,700 and the published salary ranges for the role. Against those, the offer was a S$500 rise and roughly in line with the market. She doesn't regret staying, because she likes her team, but she wrote that she'd want to decide that way for the right reason next time. No tag, though she added "comparison" in the pattern column of her log.
Her third decision was keeping the unit trust from lesson 2.4. Her reference point was "it's the one I've always had". Against the better reference point, the question of whether she'd buy it today, the answer was probably not, at an example cost of S$240 a year. She tagged it EE.
After three reviews, most people notice that one reference point keeps causing trouble. For Hui Min, it's the purchase price. She held a loser, she nearly held a second one last year, and she remembers selling a winning stock early because it was "up enough".
Her rule reads: "When I'm thinking about selling an investment, I write today's value and my target allocation first, and I don't look at the purchase price until I've decided."
Work through your three decisions in the same order, and when they're done, write the one rule you'll use the next time a possible loss is on the table.
Complete the review for three decisions and write one rule you will use next time a loss is on the table.
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