Overcoming the Endowment Effect
Jason Zweig penned a piece for the Wall Street Journal concerning what behavioral economists call “the endowment effect.” Our investments or speculations become a part of us and we will value it higher than the market does. Richard Thaler did experiments in the 1980s with a simple coffee cup. One group could buy a mug, one group was given a cup and could sell, and the other group had the choice of cash or a mug.
As Zweig writes, “Then everyone was asked: How much money is equal to having the mug?
“People who already owned a mug demanded more than twice as much for it, on average, as those who didn’t own one were willing to pay.”
Zweig uses the endowment effect to explain gold bugs, who he contends hold gold as inflation hedge, when in his view it is not. He doesn’t address other reasons for holding the yellow metal.
Bond bears who have been wrong for two decades are also lumped in as endowment effect losers as well as Amazon stock haters who are “perennially calling it an absurdly overpriced stock, [and] have missed out on gargantuan gains.”
Zweig suggests “Before you know it, you’ve become a true believer: clinging to your investment idea as passionately, rigidly and unquestioningly as a religion or ideology.”
Those of us who have studied market booms and busts, written a book about such episodes, not to mention living through a doozy in 2008 tend to cling to the true belief that a crash is around every corner, forgetting about, and sitting out, the booms which come beforehand.
In the comments section Zweig is taken to task by Y.C. Sung, “Behavioral finance has an explanation for everything... in hindsight. If you hold an asset too long, it's "endowment effect", but if you sell an asset too early, it's "disposition effect". Which one is affecting you while you're holding the asset? Who knows.
“Behavioral economists will happily explain what you did wrong after you've done it.”
Yes, but the point is, there is something to learn for next time.
Behavioral Economics.com says, “The disposition effect refers to investors’ reluctance to sell assets that have lost value and greater likelihood of selling assets that have made gains (Shefrin & Statman, 1985). This phenomenon can be explained by prospect theory (loss aversion), regret avoidance and mental accounting.”
Zweig makes the point about avoiding regret that “pain is more intense than pleasure,” and remembers Prof. Thaler telling him, “What investors fear even more than losing money is having to say, ‘What an idiot I am.’”
We all want to be right, thus, we’re willfully blind about the accuracy of what we know and learn. “When you’re highly confident, your brain becomes more receptive to information that confirms your original view,” Zweig explains, “while the processing of other data that could disprove it is ‘abolished,’ a recent neuroscience study found.”
Zweig says to think like a trader. But most people aren't wired that way. A trader like Tony Greer, appearing on Real Vision had said the crypto market looked awful, but, last week, when asked by Ash Bennington, he admitted, “ I am flabbergasted by the Bitcoin performance to the point that I added the Coinbase IPO, COIN, the ticker, to my view matrix just yesterday.”
Later he said, “we [Bitcoin] start slicing through the moving average resistance levels on the upside through 38k, 40k and 42k. You've got me hook, line and sinker in terms of paying attention to that price action because that price action was literally the most impressive price action I've seen in any security all year.”
Greer is no Hodlr or Crypto evangelist, just a trader trying to make money. “So, with my uneducated opinion in Bitcoin,” he said, “all I've got is the chart and my desire to not miss out on this trade as a lifetime thing. So, I've forced myself into it.”
It's hard to force yourself into investments or speculations you don’t believe in, but, oftentime, that's what it takes to make money.
