The funding lesson from a US arduous rock band

Van Halen was an iconic American arduous rock band, which—amongst different issues—was recognized for its energetic reside exhibits. In the Nineteen Eighties, the band had a particularly curious situation of their contract for reside exhibits. The organizers on the venue the place the present was occurring had to offer them with a big bowl of M&M candies containing all the usual colors besides brown. The authentic M&M sweet had a semi-sweet chocolate filling. The closest Indian equal of it might maybe be Cadbury’s Gems chocolate. Now this situation wasn’t simply randomly launched into the contract. Before each present, David Lee Roth, the lead singer of the band, would personally verify if the venue had made certain that the bowl of candies had no brown colored candies in it.

What was the concept behind this? As Daniel Simons and Christopher Chabris write in Nobody’s Fool: Why We Get Taken In and What We Can Do about It: “His logic was that if the organizers did not comply with such a easy instruction, they shouldn’t be trusted to have safely put in the entire rigging, wiring, staging, lighting, and pyrotechnics for a fancy present.” And if the organizers failed the brown M&M candy test, the band paid more attention to the staging of the concert. As the authors point out: “Van Halen’s rider was what scientists might call a positive control, an extra experiment that checks whether everything is working as it should.” The level being that it wasn’t potential for the band to verify every thing for themselves earlier than a reside present. At the identical time, the sweet take a look at was higher than taking the assurances of the native organizers at face worth. As Simons and Chabris level out: “Simple checks are by no means good, however blind acceptance is a horrible various.”

This instance has an investing lesson in it as nicely. But earlier than we perceive that we have to perceive one thing termed as the reality bias. As Cass R. Sunstein, an American authorized scholar, writes in an essay: “People are likely to assume that what they hear is truthful, even when they’ve wonderful purpose to not imagine what they hear.” Now this makes sense primarily because of two reasons. First, most of us are speaking the truth, most of the time. Second, it’s evolutionary. If human beings start questioning everything and anything, most of what keeps life going—the everyday decisions and transactions we make—would unravel pretty soon. Nonetheless, the truth bias—trusting what we are being told—hurts us when during the course of investing we become victims of a scam or even a misleading sales proposition.

Take the case of individuals who end up investing in Ponzi schemes which promise very high rates of return. A Ponzi scheme is an investment fraud where the first round of investors are paid using money being brought in by the second round of investors and so on. It keeps running until the money being brought in by the investors into the scheme is more than the money leaving it, and when the situation reverses, the scheme collapses.

In almost all these cases investors get focused on the high rate of return, believe that the return will be delivered and end up investing in the scheme. In that sense they become victims of the truth bias. Of course, there is no way that they can completely verify every piece of information they come across regarding the investment scheme. That’s not possible. But they could do what Van Halen did. Carry out a simple check before investing. And what would be this simple check? It can be a simple question to the individual selling the scheme: “How are you offering such a high rate of return in comparison to everyone else?” Just this thought would be certain that they don’t spend money on the Ponzi scheme.

Or take the case of what many wealth managers and relationship managers do as of late. They cross off investment-oriented insurance coverage schemes and even fairness mutual funds as schemes which supply assured returns. A easy method to take care of this case is to ask the place does the assure seem in writing.

The ethical of the story as Simons and Chabris put it’s, “Accept much less, verify extra,” particularly in terms of investing one’s hard-earned cash.

Vivek Kaul is the writer of Bad Money.

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Updated: 06 Aug 2023, 09:54 PM IST