5 days ago4 min read

The Endowment Effect

Author: Qinghao (Tommy) Ma

Editors: Suri Liu and Sophia Chen

Artist: Tracy Xu

Imagine you’re handed a free coffee mug at an event. It’s just an ordinary item, but after a while, it feels special, making it harder to let go of, even if you never really needed it in the first place. That’s the endowment effect in action—a fascinating psychological quirk where we value things more simply because we own them. Investopedia explains this as a phenomenon where people tend to overvalue possessions, whether it’s a simple mug, an old pair of shoes, or even stocks. This attachment isn’t purely sentimental. It’s deeply rooted in human psychology, mainly due to two main reasons: ownership and loss aversion.

When you own something, it becomes an extension of yourself, and this personal relationship increases perceived value. Simultaneously, we are wired to avoid losses more than we're motivated by potential gains—that is, the pain of losing something we already have is much greater than the pleasure of gaining something new. This is why people don't want to let go of things even when it would seem rational. For example, think about cleaning out your closet and getting rid of an old sweater. The potential loss seems more significant than it really is.

Not everything about the endowment effect is bad, however. Cognitive bias can help develop emotional attachment by creating sentimental value with objects that may possess importance in our lives. Objects like heirlooms, gifts from loved ones, or even things from our childhood tend to develop emotional worth due to this effect. This provides comfort and makes us appreciate our possessions by adding meaning to them. Sometimes, the endowment effect may help people make rational decisions. Investors who are confident about the long-term values of some unpredictable markets, and therefore hold on to certain assets, get to enjoy the benefit when others quickly sell.

Like many psychological biases, the endowment effect sometimes leads us off-track. Its downside includes the encouragement of poorly performing assets overestimated by individuals. This leads to disorganization and clutter. For example, it may involve holding on to a stock when one is too convinced by its worth, just because they own it, even if all signs may say otherwise. Similarly, it does the same to our personal belongings by making us resistant to disposing of anything that we own. You may keep an old phone or gadget much longer than you need to, simply because it is yours, even though you will never use it again. Companies and marketers are well aware of this bias and use it to manipulate customers often, which is why so many free trials or "try before buy" offers are made. Once you have used something or gained experience from ownership, you are much more likely to feel attached and eventually pay for it. Similarly, loyalty programs tap into the endowment effect by offering ownership at discounted points with hopes of keeping customers returning.

So, how might you overcome the endowment effect when it's leading you toward poor decisions? A simple but effective strategy is to step back and think like an outsider. When you're faced with the decision to keep or get rid of something, ask yourself, "If I didn't already own this, would I go out of my way to buy it?” These questions help break the emotional bond and allow you to look more objectively at the situation. Another way to overcome this bias is by setting clear goals, especially when investing. By having a plan in place, the likelihood of you making decisions controlled by emotions is slim; it is always based on rational choice.

The endowment effect might be a powerful lens through which to view ownership's influence on how we view the world. Though it often leads us to cultivate attachments to meaningful objects and helps us avoid making hasty decisions, it can also lock us in and make it hard to let go of things that no longer serve us well. Next time you are unwilling to let go of something, take a moment and ask yourself: Are you valuing it for its true worth or is this a trick played by the endowment effect? Recognizing this bias might be an important step toward being more composed and thoughtful when making decisions in everyday life. Sometimes, after all, it is letting go that allows one to move forward.

Citations:

“Endowment Effect.” Endowment Effect - an Overview | ScienceDirect Topics,

www.sciencedirect.com/topics/psychology/endowment-effect. Accessed 25 Sept. 2024.

Achtypi, Elena, et al. “The Endowment Effect and Beliefs About the Market.” NCBI, 23

November 2020, https://www.ncbi.nlm.nih.gov/pmc/articles/PMC7983076/. Accessed

25 September 2024.

Caceres, Andrea. “The Endowment Effect | St. Louis Fed.” Federal Reserve Bank of St.

Louis, 1 April 2022, https://www.stlouisfed.org/publications/page-one-

economics/2022/04/01/the-endowment-effect. Accessed 25 September 2024.

Costagliola, Diane. “Endowment Effect: Definition, What Causes It, and Example.”

Investopedia, 17 February 2023, https://www.investopedia.com/terms/e/endowment-

effect.asp. Accessed 25 September 2024.