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Endowment bias – Yes you suffer from it and it’s keeping you from getting richer

Mar-29-2022


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For most things are differently valued by those who have them and by those who wish to get them: what belongs to us, and what we give away, always seems very precious to us.”
Aristotle,  ~ 330 BC

 

Have you noticed that whenever you ask friends, family or colleagues about which car to buy, investment to make or even home décor suggestions, they are most likely to recommend the car model they own, an investment they made or even the type of furniture they recently purchased even though they know that many other options exist that if looked at objectively, are likely to work better for you or even for them.

This bias toward over-recommending and thus over-valuing assets and items we already own is called the ‘endowment bias’ or the endowment effect as coined by economist Richard Thaler.

We tend to value things we own more often on account of the fact that we invested time and our attention in making the decisions to own them.
And of course, as human beings the suffering of losing something outweighs the pleasure of receiving something identical – something that would not bother a truly rational human being but then who is.

The endowment bias is almost a part of human nature with significant repercussions on how we live and also how we look at money and wealth.  Here are some examples of the bias affecting our money choices –

Example 1:  I  purchased XYZ banking stock and it’s doing okay but not as well as other banking stocks.  I am unlikely to sell XYZ stock and invest the proceeds in another stock which I know is doing better because I am somewhere emotionally attached to XYZ too.

 

 

Example 2: We all know of property owners who over-value their properties when selling but are likely to value almost identical properties owned by others for less. This may in part be due to the fact that when we sell something we own, we tend to feel a sense of loss and human beings are loss-averse.  In financial matters, a ‘sense of loss’ may quite likely lead you to lost gains.

 

 

Example 3: I will continue to invest in investment product XYZ like my parents even though I know that higher returns options exist that can fulfill my investment goals better. This line of thinking was explained by Dr. Thaler as a combination of under-valuing opportunity costs of choosing other available options along with psychological inertia introduced by existing familiarity of the current (endowment) option.

 

 

We can all be smarter with our money and meet our financial goals faster if we recognize our own endowment biases. This will help us avoid unwise investments, stop us from failing to dispose of familiar but suboptimal assets and replace with better ones.

 

Author: Neha Juneja

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