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.

Points scored

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.

Points scored

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!

Comments

Today's Special: Humble Pie

You champion a project, fight for an idea, and then...reality sets in. That churning in your stomach isn't butterflies, it's the realization you've missed the mark. Pride will puff up your chest, and kick in the "defend at all costs" instinct. But arguing with the umpire never changed a call. Admitting you're wrong isn't a sign of weakness. It can strengthen your professional standing. In a world obsessed with the illusion of infallibility, the courage to adjust course is a breath of fresh air. It shows you're confident enough to be wrong, and adaptable enough to learn from it. Do your research, think critically, and stand behind your decisions. But when the data whispers (or screams) otherwise, don't be afraid to swallow that slice of humble pie. Be the first to acknowledge. Don't wait for someone to point out your mistake. Be open, take responsibility, and most importantly, focus on what you're going to do to address it. Don't dwell ...

Negative Feedback, Positive Lessons

In the battle against plastic bags, a five-cent tax was shown to be much more successful at deterring usage than a five-cent credit for bringing your own bags. Carrots satisfy but sticks sting, and they sting hard. So we default to the less painful choice of avoiding loss. Loss aversion impacts the way we process information. A 2019 study invited participants to learn through a series of multiple choice questions. Each question only had two options to choose from. Whether guessing correctly or not, they would still learn the right answer. Despite the identical learning opportunity, participants were much more successful at recalling the answers they guessed correctly than those they got wrong. "You're right!" feels good. We savour the moment, analyzing every detail. "You're wrong!" stings. We want to quickly forget, dismiss, and move on. When we succumb to loss aversion, we miss opportunities to learn. Failure is part of the process. We'll experie...

Starting Really Really Small

On your desk is one of the most intimidating sights known to man. A blank page. The prospect of filling it up with anything resembling decent seems insurmountable. Staring at the long road ahead fills you with anxiety and dread. The first step is the most difficult. So we procrastinate. We " research ", we " prep ", we " plan ". We do everything except tackling the problem. We avoid the pain for as long as we can. To make a blank page less intimidating. Tear it in half. There, half as scary, twice as easy. Still too much? Do it again. And again. Keep doing it until the task is so small that it's too easy not to do. Getting starting is the hardest part. So make the hardest part as easy as possible. This doesn't guarantee amazing results, but it gets you in the game. You can't win if you don't play.

Herman Ye

Search