Mug Madness, The Endowment Effect and Your Finances

white and blue striped ceramic mug near white painted wall

In a 1991 study, researchers randomly divided Cornell University students into two groups. One were gifted mugs, the other received nothing. The fortunate group were asked how much they're willing to sell the mug for. The mug-less were asked how much they were willing to pay.

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The owners were unwilling to sell for anything less than $5.25. The buyers on the other hand, were unwilling to pay more than $2.75. The seller's expectation was almost twice the buyer's market. This is a classic example of the endowment effect, the tendency for us to irrationally overvalue items we own.

A 2000 study demonstrated an even greater expression of the endowment effect. Duke University conducts a lottery for basketball tickets before critical games, as demand greatly exceeds supply. After one of these lotteries, researches called up a random group of winners and losers to ask about selling and buying prices respectively.

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Sellers on average expected over $2,400 for their tickets, while buyers valued the tickets at less than $200.

By overvaluing our assets, we create an inflated view of reality. We end up holding onto assets for longer than rational. Not wanting to leave money on the table, we hold onto them until we receive an offer that meets our rich expectations.

The endowment effect clouds our judgement and leads to poor financial decisions. In investing, we stubbornly hold onto bad stocks. When selling our home, we unwisely pass up fair offers.

When making sell decisions, do your best to eliminate the emotional attachment to your assets. Ask yourself "If I didn't own this already, what would I pay for it?". Habing a realistic view of your assets is essential for financial planning and decision making. Otherwise you'll never sell what you should and end up thinking your financial health is twice as good as it actually is!

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