Think something you already own is better than something you could own? Say hello to the “endowment effect”!
Seen this house before? This is what inspired Pixar’s movie — Up! Rumour has it that the owner, Edith Macefield, refused to sell the house — valued at around $120,000 — to a huge corporation that wanted to build a mall in the area. No amount in the millions could convince her to leave the house she had been living in since 1952.
Touching story. But did her decision-making actually make rational and logical sense? Let’s put this to the test with an example.
Let’s say you’re doing your quarterly “spring cleaning” ritual and you come across your old stuff, spotting a first edition near-mint condition Spiderman comic! You could easily sell that for a handsome sum anywhere online, but you decide to display it in your home office.
Now put yourself on the buyer’s side. You come across the same comic online and see it priced at 2.5 lakhs. I can’t dream of spending that kind of money on a single comic book!”, you think.
In theory, these reactions sound perfectly normal. Most people would, in fact, react this way. But in logical and economical terms, they make little sense. This is actually because of something called the “endowment effect”.
What does it mean?
As people who navigate through life with our emotions, we assign more value to things we already own instead of the things we could own. That’s not inherently bad. Emotions are an important factor to consider when making financial decisions. That’s why behavioural economics exists! But emotions do sometimes lead to unwise decisions with our money and assets.
The endowment effect has been displayed time and time again when it comes to investing and marketing. Even when individual stocks of companies have performed terribly, investors are super reluctant to book losses for similar but better-performing stocks.
Some other examples…
Ever wondered why some apps like Spotify and Piccolo offer months’ worth of free content with ads and interruptions without charging you? You can thank the endowment effect here.
Apps try to create a sense of “partial ownership” by letting you use it for free. If they’re able to make you feel like you own it already, you’re much more likely to actually spend money at the end of the free trial! Similarly, companies like Nike and Adidas allow you to personalise your sneakers directly on their website with colours and textures before you even buy it, capitalising on the “endowment effect”.
How can you tackle this?
In reality, emotions are intertwined with every single decision we make. Money as well. Managing and regulating your emotions when it comes to financial decisions by taking a step back and evaluating your options could, perhaps, help you look at situations from a slightly different perspective.
It may even compel you to sell that mint-condition comic book the next time.
But before you do, check out some of our other blogs in this series…
· This is how no-cost EMIs ACTUALLY work