Endowment Effect in Investing Explained

The endowment effect is closely related to loss aversion and is another emotional bias. It refers to the fact that investors tend to irrationally value things they own more than their market value. That is, they value the same investment more if they own it than if they didn't own it. Loss aversion can contribute to the endowment effect. The endowment effect causes investors to irrationally hold on to losing or suboptimal investments longer than they should. An example would be an investor who inherits and holds on to shares of stock from a relative, which may have a sentimental value when there's no rational reason to not sell the stock. If the stock is declining, the investor may irrationally believe it is due for a rebound, when in reality the investor should treat it as a sunk cost and cut their losses. Another common example is to accumulate, become emotionally attached to, and refuse to sell stock of one's own employer, causing the investor to be dangerously overexposed to the economic risks of one single company. Ask former Enron employees how that worked out for them.

#investing #biases #cognitivebiases

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