Not long ago, I reviewed William Poundstone’s Fortune’s Formula, a very good and relevant book about the common mathematical roots of gambling and investing, which I originally picked up as part of my poker-playing research.
Poker is based on probability and, to a much greater degree, on psychology. I did all right in my poker playing, ending up well in the black, but ultimately became much more interested in the markets, which is why I’m doing what I do now.
Behavioral finance is the study of psychology as it applies to investing and portfolio management. Researchers have identified many different behavioral biases that can damage an investor’s decision-making process—information that can be incredibly valuable to practitioners. What is usually presented, though, are facts and applications, rather than the underlying research.
In Priceless, Poundstone takes the opposite approach. As in Fortune’s Formula, he walks readers back through history, introducing us to the people who developed the ideas and then following those concepts into the present. As a result, you not only understand the idea but the context from which it arose and how it evolved over time.
This type of background is helpful in grasping the concepts Poundstone presents, like the lack of solid basis in how prices are constructed. Anchoring, for example, is a well-known behavioral basis. Showing how this bias plays out in multiple contexts, such as the two-offer ultimatum game, alcohol-fueled negotiations, or money illusion in Zimbabwe, offers a much clearer picture—to me, at least—than the typical presentation.
Beyond context, Poundstone provides useful, and extremely entertaining, examples. (This is where the “How to Take Advantage of It” part of the title comes in.) Among these illustrations are the “free” 72-ounce steak, which he uses as a segue into supermarket pricing; $14,000 Ralph Lauren handbags, which leads into a discussion of two competing bread makers at Williams-Sonoma; and $100 hamburgers, which segues into a look at the Chili’s menu, with its stars, puzzles, plow horses, and dogs.
At the end of the book, you’ll have a much better understanding of the underlying economic psychology of retail and how many businesses set their prices. You’ll also be better positioned to set prices for your own business or evaluate those being offered to you.
I initially picked up Priceless simply because I liked Fortune’s Formula. My interest in pricing wasn’t that high, and I didn’t expect the book to have such depth and relevance to all areas of business and investing. I was also pleasantly surprised by its entertainment value—few books have given me a better mix of content and entertainment.
Priceless is definitely popular science, not a textbook. But the content is real, and the spoonful of sugar doesn’t make the medicine any less effective.