Endowment bias…have you ever held onto an investment that lost value in the hope of a future recovery? Even if it were more rational to cut your losses and sell? Most people have. So how do you fix it?
What’s Endowment Bias
Endowment bias is a cognitive bias that refers to the tendency of individuals to value an object, asset, or possession with a higher value simply because they own it. People will often overvalue something they already possess compared to its objective market value or the value they would assign to the asset if they did not already own it.
This bias suggests that people ascribe additional value to something they own due to a psychological attachment, a feeling of control over the object, or a sense of ownership.
Several Examples
For instance, let’s say your uncle owns a 1976 Coupe deVille Cadillac and he is thinking of selling it. The market for these cars is robust; the typical price is ~$30,000, but he says, “No way, my ‘76 Coupe deVille is worth at least $45,000. I bought it right from the factory.” He lovingly changed the oil every 3,000 miles, washed and waxed it consistently, and parked far away to prevent dings.
Another example is your vested RSUs of the company where you work. They are trading at $80/share but you think that they are worth $125. This is a classic example of endowment bias. You may think that you have a better sense of the share price because you spend most of your waking hours working for your company. You know about the great employees and the exciting new products in the pipeline.
Recognizing endowment bias is important in decision making. If not detected, it can lead to suboptimal choices and impact financial outcomes.
Furthermore, awareness of the bias does not prevent its effect. Having an objective, knowledgeable partner on your side helps you see your company stock’s value more clearly, and within the context of your overall financial plan.
You may remember Gordon’s mistake, where he lost $10 million dollars because he was waiting for his company’s share price to increase back to its original value. You don’t want to be like Gordon. I can help you.
If you’d like to talk about company shares, endowment bias and how to avoid it, reach out for a complimentary consultation.