Endowment effect makes investors overvalue assets they already own from "summary" of The Little Book of Behavioral Investing by James Montier
The endowment effect is a psychological phenomenon that causes people to place a higher value on objects they already possess compared to identical objects they do not own. This bias can have significant implications for investors, as it can lead them to overvalue assets they already own. When individuals become attached to an asset, whether it be a stock, a house, or a piece of art, they tend to have a hard time letting go of it. This emotional attachment can cloud their judgment and cause them to assign a higher value to the asset than what it is objectively worth. Investors who fall victim to the endowment effect may be unwilling to sell an asset even when it no longer makes financial sense to hold onto it. They may hold onto losing investments in the hopes that they will turn around, or they may refuse to sell a winning investment because they have become attached to it. This behavior is irrational from a purely financial standpoint, as investors should be making decisions based on the expected returns of an investment rather than their emotional attachment to it. The endowment effect is rooted in loss aversion, which is the tendency for people to prefer avoiding losses over acquiring equivalent gains. When investors have owned an asset for a significant amount of time, they may feel a sense of ownership over it and be more averse to parting with it, even if selling the asset would be the rational choice. This can lead to suboptimal decision-making and prevent investors from maximizing their returns.- Investors should try to detach themselves emotionally from their investments and make decisions based on objective criteria rather than subjective feelings. This may involve setting clear investment criteria and sticking to them, regardless of emotional attachments. By recognizing and mitigating the impact of the endowment effect, investors can make more rational decisions and improve their overall investment outcomes.
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