Endowment Effect

Ok, here is something interesting from my (daily) world of business and financial psychology:

When I started out in 2007 it was always quite “funny” to me, when people offered me their books with the remark, that “this book belonged to my grandmother and is 100 years old” – and with an asking price which was way out of line (compared to the current market situation). I always knew that emotions play a major part (maybe the only?) when buying, but in selling I couldn’t make sense of it – despite desperation for money, of course.

But one day I actually stumbled over one of Daniel Kahneman’s work and did a little research. And there it was: The Endowment effect.

The Endowment effect explained

 

“The endowment effect is a phenomenon in behavioral economics that describes the tendency for people to place a higher value on things they own than on things they do not own. This effect is often observed in the context of buying and selling goods, but it can also apply to other areas of life, such as investing and decision-making.”

Ha! So basically, the endowment effect is rooted in the idea that people have a natural inclination to attach emotional value to things they own. It’s a fancy way of saying we value our stuff more just ‚cause we own it. So weird, but it somehow, I can relate.

While in fact many books (and other arts as well) increase their value when they were owned by famous people in the past (the term of importance is “provenience”), it is rather cute when a grandmother or other family members are hoped to qualify as well.

 

It’s all psychological – as always!

Psychology says, this emotional attachment creates a sense of ownership and control, which in turn leads to a higher perceived value of the item. This can make it difficult for people to let go of things, even if it would be in their best interest to do so.

Kahneman’s (with Amos Tversky) actual experiment revealed also, that people were willing to pay more to keep a mug they had been given, than to buy a similar mug they did not have. This study demonstrated that people tend to value items more highly when they already own them, than when they are considering buying them.

 

Endowment Effect and investing

In the context of investing, the endowment effect can lead to a bias in decision-making. For example, if an investor has a stock that has been performing well, they may be less likely to sell it, even if market conditions change and it would be more profitable to do so. Similarly, if an investor has a stock that has been underperforming, they may be more likely to hold onto it, in the hope that it will recover, rather than selling it and taking a loss.

The endowment effect is not just limited to material objects, but it can also be seen in other areas of life, such as jobs, homes and even relationships.

Ok, here is my practical advice (if I may repeat myself): To avoid the endowment effect, it is important to be aware of it and try to separate emotions from decisions. It’s also important to have a clear plan and set of objectives, and stick to them, even if it means letting go of something we own. Additionally, it’s important to seek out multiple opinions and consider different perspectives, and also get a second opinion from a financial advisor or expert before making any decisions.

 

Conclusion

So in conclusion, the endowment effect is a phenomenon that demonstrates how emotional attachment to things we own can affect our perception of value and decision making. However, by understanding and being mindful of it, individuals can make more rational and profitable decisions in various areas of life.

If you want to find out how these emotions are rooted deep within us, (the Buddhist call it “Wanting Mind”), check out my brand new pdf about exactly that – and what we can (and should) do about it before it interferes or even determines our decisions.