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Beware of Shifting Reference Values!
Linda Goin
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Just about every one of us is a super pro at shopping. We know about clipping coupons, we hunt diligently for the best prices, and we watch like hawks for the best time to buy. It's a skill and a talent, this innate shopping gene.
For instance: One store advertises a sale at "40% off everything!" Another store advertises, "Sale prices are 40% of the original price!" Which store will grab your attention, time, and money?
For those novices at shopping, it goes like this: The first
store is offering 40% off everything, which means that everything
in the store is 40% less than its original price. So, the sale
price is (100 - 40)% = 60% of the original price. If the original
price was $100, the sale price is $60.
The second store is a better deal, since 40% of the original price is whatever the original price is multiplied by 40% (or .40). If the original price was $100, the sale price is $100 x .40 = $40. Got it? Wording is everything!
What puzzles me is this: if we're such pros at figuring out percentages on sales, why aren't we just as proficient at figuring percentages in advertising for other products and services? I don't believe it's because of missing brain cells. I believe it's because we're too trusting. If we were more aware, we'd know how representative figures are often skewed to the business owner's advantage.
Our bosses might understand this notion of skewing representation of percentages and they often use this tool with great skill. Mind that I said the representation of the figures are skewed - not the figures themselves. Just like last year, when your boss asked you to take a 10% pay cut for six months, with the stipulation that you would regain that 10% when things would - hopefully - be a bit better economically. Since you felt relieved you didn't lose your job, you took the deal.
You lost some money, honey - and it was for the long haul. Why? Well, suppose your salary was originally $400 per week. A 10% pay cut means your pay will decrease by 10% of $400, or $40, so your weekly pay after the cut is: $400 - $40 = $360.
The economy takes an upturn, and your 10% increase is in the next check. Surprise! Your paycheck is now only $396.
What happened? For one thing, your boss was good to the 10% word - literally. Your 10% increase was based on $360, rather than the original salary of $400. It might not seem like a lot, but a $4 decrease in pay per week is $208 per year. That's almost half your weekly wages. This is called a "shifting reference value" and people often use it to represent percentages to their advantage.
Another play on shifting reference values is what I call the "Politician's Ploy." This happens when a politician promises to "...cut your taxes by 10% for each of three years of my term, for a total cut of 30%!"
Use your innate talent to evaluate this promise. The politician neglected the effects of shifting reference values. A cut of 10% in each of these three years will not make an overall cut of 30%. Suppose you pay $1000 in taxes. For the first year, your $1000 will be cut by 10% ($1000 x .10 = $100), so your taxes will be $1000 - $100 = $900. What a deal!
Year two, however, is 10% off $900, which is $90. Your taxes that year are $810. The next year, your taxes will be 10% off $810, and you will pay $810 - $81 (10% of $810) = $729. Over three years, your taxes didn't decrease by 30%. If they did, you'd only pay $700 in taxes. Over three years, your taxes declined by $1000 - $729 = $271. This is only 27.1% of $1000.
You might call this nitpicking, but it's important information to understand. If we're so careful about our day-to-day purchases, why do we get so snowed over larger issues? Every penny counts, especially if you have a difficult time scraping money together for that portfolio.
Which brings us to stock market figures, especially in reference to company presidents and financial statements. These past two years have been a doozy for falling stock market prices. The company president of your major stock purchase just made a statement, and you might buy what this person says:
"We admit the value of your investments in our great company fell 60% during the past two years. This year, however, the value of your purchase has risen 75% due to our increased diligence and smart planning. You are now 15% ahead in your investment!"
Knowing what you know now about shifting reference values, is this person correct? I don't think so.
If you invested $1000 in XYZ Company two years ago, and you lost 60%, the value of your stock is now $400. If your investment increased by 75% during the past few months, it only increased on the current value of your stock, not the original value. So your stock is now at $400 x .75 = $300. Your $400 + $300 = $700, which is $300 LESS than your original investment. You're still under to the tune of 30%, not ahead by 15%. Granted, it's great your company appears to be on an upturn, but watch that stock, and especially watch the president of that company and his board. If they think they can pull the wool over your eyes, they either believe their investors are gullible or they're just plain dumb when it comes to numbers. Both scenarios are serious problems for investors.
This is a simple lesson, but it's stage one for upcoming weeks. If you're like me, you might have a tough time with compounding, along with investment planning. We'll cover all this and more against the will of my daughter, who would rather talk about clothes and boys.
Until Next Week,
Linda Goin
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