The Endowment Effect: Why We Overvalue Our Stuff

The endowment effect can be an obstacle to a minimalist lifestyle, as well as inhibiting financial decisions. So what is it? And how can we control it?

He might loathe the idea, but my father is an excellent case study. Like many 60-something retirees, he has accumulated a lot of stuff. This isn’t just a result of the passage of time, but a predilection for finding it, repairing it and keeping it.

There are several lawnmowers, despite only one lawn – and one person to mow it. There is enough seating for 200 esteemed guests, despite a complete absence of any desire for such a gathering. The garage screams for breathing space among the unused tools, ornaments, electrical appliances, books, you name it.

In short, my father loves accumulating but hates letting go.

It’s until only recently, confronted by the idea of loading all this stuff into lorries for a move to a new house, that he’s started to consider the idea of freeing up space. Naturally, I offered my services. Not keen to get an account himself, I offered some help with selling items on eBay. Free up space and make some money. What’s not to like for my father?

Except, it’s not proving easy. Within the jungle of paraphernalia in his garage there is unquestionably value. The problem is, his measure of that value is very different to reality. Almost every item is overvalued, despite my best protests, and so we are left in one repeated auction after another.

My father is experiencing the potent effects of ownership. We see it when selling our houses, furniture, clothes, art, stocks and shares. If we own something, we can be hindered by it. It goes by the name of the endowment effect.

What Is the Endowment Effect?

The endowment effect is a cognitive bias that describes our tendency to overvalue something that we own, regardless of its real market value. Psychologists have proposed a variety of explanations for this effect, but it’s commonly put down to loss aversion and emotional attachment (sometimes referred to as a ‘mere ownership effect’).

The Endowment Effect and Loss Aversion

Imagine you’ve just purchased a lottery ticket. As you leave the shop, I offer to pay you double what you just paid for it. Would you accept my offer?

Most of us would say no. Why? Because despite the infinitesimal chances of winning, the thought of losing out overpowers statistical logic. What we now own could be our ticket to freedom. The ticket therefore takes on a higher value in our ownership.

Loss aversion like this is the most common explanation for the endowment effect. We hate the idea of losing money on something we own. So much so, that we prefer avoiding a loss of $5 to gaining $5.

This is one of the main reasons why the endowment effect is so palpable in finance. While a stock might be destined for failure, the endowment effect can leave us holding on for too long.

The Endowment Effect and ‘Mere Ownership’

But loss aversion doesn’t fully explain my father’s choices. Something else was afoot. His connection to these items was biasing his valuations. Because he simply owned them, this was somehow playing a role in distorting his valuation.

In studies this is typically demonstrated in experiments where participants are randomly assigned ownership of items for free. Other participants are then assigned to evaluate the same item without receiving it. The result? Participants who own the item typically rate it as more attractive than participants who don’t.

Dan Ariely describes something like this effect in his book, Predictably Irrational (UK, US). As an experiment, Ariely raffled tickets to a major baseball game. He then asked students how much they thought the tickets were worth. Those who didn’t win reckoned they were worth $170. Those who had won, on the other hand, wouldn’t sell for less than a whopping $2,400.

In seminal work on the endowment effect in 1991, Daniel Kahneman, Jack Knetsch and Richard Thaler demonstrated the same effect – this time with coffee mugs. Those assigned as sellers valued the coffee mugs much higher than the buyers.

Funnily enough, we even see this effect when we don’t own the item yet. At auctions, a successful bid can drive a sense of emotional attachment that leaves us bidding into overvaluation territory.

As well as the effect of mere ownership, my father’s emotional attachment to items, on the other hand, is reinforced by his memories of salvaging and repairing them.

The Endowment Effect and Belief Perseverance

One of the reasons we have faced such difficulties selling this stuff is belief perseverance. Put simply, belief perseverance is the tendency to hold firm with our beliefs even in the face of contradictory information. I’ve observed with some amusement how this phenomenon has swayed my father’s valuations.

In particular, two belief perseverance errors have influenced his valuations:

  • Conservatism bias: This is where we give more weight to old information than new information when forming our beliefs. In the case of my father, this meant that because he had checked the value six years ago when he’d first repaired the item, he felt that the value should hold in the present.
  • Confirmation bias: This is where we only notice information that agrees with existing beliefs (more on this here). It’s this bias which has been the thorn in my side. Because he’d invariably seek out the highest valuation of the same item on eBay, regardless of whether or not it had sold, he’d present this as a case for our own valuation.

You can quickly see how such biases fortify the endowment effect. Combined with our own sense of loss aversion and emotional attachment, our valuations of the things we own defy the external reality.

Minimalism and the Endowment Effect

As a nascent minimalist, the endowment effect has the potential to be very unhelpful. Overvaluing our stuff is unlikely to help us declutter and free up space. On the contrary, it’s likely to have the opposite effect.

As we bring in the new, our overvaluations lead to accumulation, because the endowment effect inhibits our ability to get rid of the old. My father – and most of us, for that matter – are excellent examples of this accumulation with the passage of time.

It’s also pervasive in personal finance. One of the reasons we struggle so much to reverse lifestyle inflation is because we overvalue what we’ve accumulated.

So how do we overcome it?

Awareness of this psychological trap is the first step, but it’s no guarantee against the powerful influence of loss aversion and emotional attachment. Instead, in his bestseller, Thinking, Fast and Slow (UK, US), Daniel Kahneman suggests a more traditional remedy: experience.

Studies have shown that those with experience of trading are much less affected by the endowment effect. Experienced traders pay more attention to objective market value than to our internal monologue. (There are, of course, many real-world exceptions!)

A Sentimental Ending

Not everything can be treated as a commercial trade. Sentimentality also has a powerful and positive psychological role. We should distinguish those items that weigh us down with unhelpful emotional attachment and those few items that provide meaningful sentimental value.

If we make that distinction, while aware of the traps of the endowment effect, we can begin to value our stuff fairly. That can be the start of a journey where we discover less is so often more.

Now, if you’ll excuse me, I have some work to do with my father on this front.

Epilogue

As I re-read and put the last words to this article, my phone buzzes. “Bid received”. Foolish be the man who doesn’t listen to his father.

Just another 50 overvalued items to sell, then…

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