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Latticework of Mental Models: Network Effect

I clearly remember the day, it was in July 1999, when I was first introduced to the internet. I was so excited to get a brand new email address. I could now send and receive emails.

However, the excitement didn’t last very long. I quickly realized that the email address wasn’t of much use to me because none of my family or friends had any email addresses at that time. Who would I mail?

But slowly as more and more people started using internet, my email address became increasingly valuable.

Similarly, I remember the time when the social networking bug bit me and I signed up for Orkut. But within few years when all my friends had moved to Facebook, I was forced to abandon Orkut and climb on the Facebook bandwagon.

So you’d notice that the utility of certain products and services is directly proportional to its number of users. Another recent example that comes to mind is the social messaging app Whatsapp. There are quite a few other messaging services which offer better features than Whatsapp but majority of people continue to use Whatsapp because all their friends are on Whatsapp.

This is called Network Effect. Now the idea may sound very simple, but it’s actually fairly unusual.

When you board an airplane, do you get excited when you see that the flight is completely full? Or when you visit your favourite restaurant, do you prefer it to be crowded? In these cases, as a consumer you don’t get any benefit if the product or service is also being used by others.

But when it comes to social networks like Facebook, Linkedin and Twitter, members join these networks because other members are in this network.

Poke the Box: It’s a Marathon, Not a Sprint

Let’s Start with Safal Niveshak
Here are some useful posts from Safal Niveshak archive which you might want to read again…

John Templeton was the founder of the Franklin Templeton Group. His 16 rules for stock market success.
A big lesson I wish I’d learned early in my investing life.
Have you taken your investment oath? If not, here’s one to get you started. Print it, fill it, stick it in front of your work desk, read it, and practice it every day.
How to increase your savings by 9200%. A real life story.

Book Worm
Rolf Dobelli’s The Art of Thinking Clearly is one book I like going back to again and again. Dobelli has done a fine job of compiling a list of mental models especially from the field of psychology.

Winner’s curse is an interesting mental model capturing the auction phenomenon. Dobelli writes –

Latticework of Mental Models: Liking Bias

It was March 2007 and I was desperately looking for a tax saving investment product. Until that year I had been sticking to the old fashioned conservative options like tax saving FDs and LIC policies. But the stock market frenzy of 2007 was rubbing off on me.

So when I received a call from a stranger who called himself a “financial advisor” and showed a great concern for my financial well being, I couldn’t say no to his request for a meeting.

Although the young chap seemed to have just a few years of experience in the industry but his demeanor were nothing less than that of a CEO of a large company. He was well dressed, tidy, confident and articulate.

When we met he took interest in my hobbies and complimented me about my reading habits. Needless to say I took an instant liking to him.

He told me about a new financial product called ULIP (unit linked insurance plan). I had never heard of ULIP, so before committing any money to it I borrowed some time from him and did a quick research on google. The reviews on the internet weren’t very encouraging. Some even claimed of unethical mis-selling by private banks and insurance companies as far as ULIP was concerned.

But my financial advisor seemed to know what he was talking and I liked him. He even told me that one of his elder cousin was from my college. So I went ahead and (mis) invested my money.

Poke the Box: School Yourself

Let’s Start with Safal Niveshak
Just in case you missed any of this on Safal Niveshak in the last week…

As humans, we don’t only imitate good actions, but we also have a tendency to follow wrong actions and inactions of fellow humans. The Bystander Effect.
Switching costs create moat but what creates switching costs?
A combination lock should really be called a permutation lock. Find out why.

Book Worm
The Elements of Investing is a short, straight-talk book about investing and saving. While talking about power of saving and compounding, authors, Burton Malkiel and Charles Ellis, write –

Time is indeed money, but as George Bernard Shaw once said, “Youth is wasted on the young.” If only we could all train ourselves at a young age to know what we know now. When money is left to compound for long periods, the resulting accumulations can be awe inspiring.

Benjamin Franklin provides us with an actual case. When Franklin died in 1790, he left a gift of $5,000 to each of his two favourite cities, Boston and Philadelphia. He stipulated that the money was to be invested and could be paid out at two specific dates, the first 100 years and the second 200 years after the date of the gift. After 100 years, each city was allowed to withdraw $500,000 for public works projects. After 200 years, in 1991, they received the balance—which had compounded to approximately $20 million for each city. Franklin’s example teaches all of us, in a dramatic way, the power of compounding. As Franklin himself liked to describe the benefits of compounding, “Money makes money. And the money that money makes, makes money.

Latticework of Mental Models: Permutation and Combination

Here’s an interesting trivia.

If you wear different tie on the same shirt, most people will think that you’re wearing a different shirt. That’s an interesting way to multiply your options without really buying new cloths (except few new ties).

“That’s not a trivia, that’s a Jugaad.”, you might want to say. Anyways, That brings me to an equally interesting mindbender.

If you have 2 shirts (white, blue), 3 pants (black, gray and brown) and 3 different ties (pink, orange, red), in how many different ways can you get dressed? Assumption here is that getting dressed requires you to wear all three i.e. a shirt, a pant and a tie.

Using the multiplication principle we can say that there are total 2 x 3 x 3 = 18 ways to get dressed. Of course some of the dress combinations will look outright funny but our concern here is to find out all possible ways to get dressed. Moreover, today we are getting into Maths discipline and most mathematicians don’t really have whole lot of fashion sense anyways.

So that’s the simplest example of using the idea of combinations in real life. Now let’s say, for some strange reason, we were also considering the order in which you put on the cloths, i.e. it matters to us if one puts on the shirt first instead of tie.

Imagine wearing a tie first and then squeezing the shirt inside the tie, funny right? I told you mathematicians don’t care much about the dressing etiquettes 🙂

Okay, back to the same question again. In how many ways can you get dressed if the order of dressing matters?

Poke the Box: Dealing with Stock Market’s Moments of Terror

Let’s Start with Safal Niveshak
Revisiting the archives for some old posts on dealing with stock market turbulence…

How to survive a stock market panic…and make it work for you.
How to stop worrying and start investing.
What should investors do when stocks crash?

Book Worm
Yesterday, I was re-reading what Buffett wrote in his 1987 letter to shareholders, which I believe is one of the most important texts ever written on how to become a sensible stock market investor. As a student of value investing, you must have read what follows several times. But then, such super-texts need several readings, and then several more.

Latticework of Mental Models: Switching Costs

How many times in last 6 months have you bought something from any of the these websites –

Flipkart
Amazon
Snapdeal

In my case I have used all three, at least once, in last 6 months. With two infants at home, my wife’s favourite online shopping destination is firstcry.com these days. But when it comes to buying diapers, I order from Amazon. Why? Whichever website offers better discount, we go for it. I am not loyal to any particular online store.

Now let me ask you another similar question. How many times have you switched your bank in last 6 months?

In last 1 year? Or in last 5 years?

Well even if another bank comes with an offer of higher savings interest rates, how many people actually take the pains of shifting all their cash and bank deposits to another bank? Very few I guess. My father hasn’t changed his bank in last 30 years.

But why is it that we change our online shopping stores in the blink of an eye but never really change our banks. Even credit cards or demat brokers don’t see too much churning in their customers base. If you talk to bankers, you’ll find that the average turnover rate for deposits is around 15 percent, implying that the average customer keeps his or her account at a bank for six to seven years.

Poke the Box: Choose Must

Let’s Start with Safal Niveshak
As Mr. Market behaves like a drunkard trying to get on a horse, here’s time to revisit some old posts dealing with how to behave during a stock market turbulence like we are seeing now –

Simple thoughts on how to deal with stock market turbulence.
Stock prices may be falling, but the stock market is getting an expensive place. Intrigued? Read this post.
Your 10 big questions on the stock market crash answered.
An old, but highly relevant presentation on the return of uncertainty, and how you can deal with it.
Curse of the bull market is back to haunt investors.

Latticework of Mental Models: The Bystander Effect

“Madness is a rare thing in individuals – but in groups, parties, peoples, and ages it is the rule.” ~ Friedrich Nietzsche

Just after 3 a.m., March 13, 1964 in New York City, Catherine Genovese, a 28-year old woman, was stabbed to death in a parking lot in front of her apartment complex. Catherine’s murder story could have drowned in the middle pages of most newspapers like many other crime stories, except that it didn’t.

Catherine’s murder wasn’t a quick, muffled death. It had been a long, loud, tortured, public event. The killer had chased and attacked her in the street three times over a period of thirty-five minutes before his knife finally silenced her cries for help.

Shockingly, thirty-eight people, all in the surrounding apartments, witnessed at least one of her killer’s three attacks from the safety of their apartment windows for 25 minutes without calling the police.

The story has since been thoroughly debunked, a case of sensational reporting, but at the time it was written it led to intense interest in the phenomenon from psychologists. Even if there is a ten percent truth to above story, it’s a baffling account of a crime, not because it was a murder, but because “good people” failed to call the police.

Why didn’t the neighbours help? Were they indifferent? Frightened? Why should they be afraid of calling the police from the safety of their own homes? Has the violence on TV and movies made people so insensitive? Was it the beginning of a new epidemic known as large scale social apathy?

Interview with the witnesses revealed none of these explanations was the real reason behind people’s inaction.

Poke the Box: Don’t Set a Bad Goal

Let’s Start with Safal Niveshak
Just in case you missed any of this on Safal Niveshak in the last week…

In investing, knowledge is cumulative and the relation between effort and results is nonlinear, so focus on the process and keep practicing the art of investing.
For investors, like airline pilots, the job entails hours of boredom punctuated by moments of terror. If you can stomach the stock market turbulence you’ll end up with very satisfactory results over long term.

Book Worm
Derek Sivers is the perfect example of what one might want to call as an accidental entrepreneur.

He was a musician who simply wanted to sell his music CDs online. In 1998 the internet was still picking up and e-commerce was pretty much an unknown phenomenon. So Derek started his own website to sell his music CDs online which, to his utter surprise, grew into a multi-million dollar business. He eventually sold his business, CDBaby.com, for $22 million.

Derek’s approach to business is very unconventional but makes a lot of sense. He has compiled his business philosophy in a small book called Anything You Want. It was an absolute treat to read this book. I just couldn’t put it down and ended up finishing this 100 page book in one sitting.