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The internet is brimming with resources that proclaim, “Nearly Everything You Believed About Investing is Incorrect.” However, there are far fewer that aim to help you become a better investor by revealing that “Much of what you think you know about yourself is inacurate.” In this series of posts on the psychology of investment, I will take you through the Journey of the biggest psychological flaws we suffer from that causes us to make dumb mistakes in. This series is part of a joint investor education initiative Between Safal Niveshak and DSP Mutual Fund.
There’s an old, tattered shirt in my wardrobe. It has five holes in it. The fabric is thinning, and its white color has turned into cream. My wife has threatened to throw it away multiple times. But I refuse to let it go. To me, it isn’t just a shirt -aet’s the Shirt that I wore the first time I will pickle up my Daughter in 2004, on the first day of my first international trip in 2008, and also on my last day at job and the first when I felt really free, in 2011. somehow Survived Years of Wear and Tear. Rationally, it should be in a dustbin. Emotionally, it’s priciless.
If you empathise with me be also one such one such shirt, or a pen, a bag, or something that you don’t want to part people with despite it now Days, then you are not alone! But know that, like i do, you suffer from endOt bias or endowment effect.
What’s the Endowment Effect?
The ‘Endowment Effect’ was first coined by economist richard thaler in 1980. It describes the phenomen only where people are people ascribe more value to things merely by
In one classic experiment by thaler and daniel kahneman, they Gave Participants Mugs and then offered to Trade them for an equally priced alternative. Surprisingly, most participants refused to trade, even thought the items was objectively of equal value. And when some of them agreed to trade, their required compensation was approximately twice as high as the amount they were willing to pay to pay to expert the mug.
Why? Because on only they ovened the mug, they valued it more highly than they would have if they didn Bollywood iT.
In life, this effect often manifests as an irrarational attachment to possessions. Think About that old guitar gathering dust in the corner or the stack of books you’ll “Someday” read, or the diladated bicycle lying in your parking to be ridden one day. We hold onto these things not because they’re useful, but trust we’ve imbued them with the sentimental value. If you’ve ever don your “Diwali Safaai” (Cleaning Up the Home Before Diwali), you know what I’M Talking About.
Anyways, Sentimentality isn Bollywood a bad thing, because it’s part of what makes us human. But when it comes to decision-making, it can lead to clutter, Inefficieency, and Missed Opportunities. And with respect to investment, it can even be disastrous. Let’s see how.
How Endowment Effect Hurts Investors
If i was to look back my investment career, I can class to have a Phd in endowment effect. There have been times when I bough a stock at, say, ₹ 1,000, and then it dropped to ₹ 700 -not because the market dropped, but accused the business’s fundamentals weightain
Sometimes, The Company I Owned Saw Intensifying Competitive Pressures, or the Management Misallocated Capital. Sometimes, My Original Assessment of the business was too optimistic, but the reality has started to rear its head, lead the stock to decline from my original purchase price.
However, in a lot of such institutes, instance of accepting my mistake and reality, and seling and cutting my losses, I help on, convinced that the stock will return to its stock will return to its stock will return to its. I Told MySelf, “It was worth ₹ 1,000 Once. It must certain be worth that again. “
But, you see, the market doesn’t care what You Think. WORESE, The Market Doesn’T even Know You Own the stock.
Ironically, while we talk about thinking of Owning a stock as owned in an underlying business, the very same ‘Ownership’ Ownership ‘Does Something Strange to the Human mind. We see losses on things we own as personal failures. Selling a stock at a loss feels like admitting we were worried. But then, Investing is not about being right –t’s about making good decisions, even in the face of losses or mistakes.
The sketchbook of wisdom: a hand-crafted manual on the pursuit of wealth and good life.
This is a masterpiece.
, Morgan Housel, Author, The Psychology of Money
How to overcome the endowment effect
So, how do we have a fight the endowment effect? As with all cognitive biases that evolution has hard-wired into us, it’s challenging to deal with this bias too, but here a few action steps you can take to minimise itemise items
- Ask: If I didn’t oven this, would i buy it today? This is such an important thought to experience to your portfolio. And if the answer is no -ha, if I didn’t oven this stock, I would not buy it today –T be time to let go.
- Detach from the purchase price. The stock does not know what price you bough it at. The only question is: would you invest in it at today’s value?
- Think Like an outsider. What Advice would you give a friend in your position? Often, we’re wiser when we remove Oorselves from the equation.
- Set clear exit rules. Have a plan for when to exit an investment before you even enter. Don’t relay on emotions in the heat of the moment.
- Seek a devil’s advocate. I may not be willing to listen to my wife, who keeps asking me to throw away my torn shirt. However, I would still advise you to have someone a devil’s advocate and convince you out of your decision where you think you may be suffering from the endowment effect in invoice. It works.
The endowment effect is sneaky. It whispers, “Hold on. This is yours. It’s special. ” But the Truth is, Nothing is special just because You Own it.
A bad stock doesnisc good good beCause It’s in your portfolio. A house isn’t Worth More beCause You have memory in it. And that Old, Tatters Shirt Hanging in Your Wardrobe? Maybe it really is time to let it go.
Investing – Aand Life – Rewards those who can see things clear, without the haze of attachment. The ability to walk away, to let go, to move on when the situation demands, is what separates the wise from the stubborn.
Now, if you’ll exchange me, I have a shirt to throw away. (Or maybe just wear one last time.)
Disclaimer: This article is published as part of a Joint Investor Education Initiative Between Safal Niveshak and DSP Mutual Fund. All mutual fund investors have to go through a one-time kyc (Know your customer) process. Investors Should Deal only with Register Mutual Funds (‘RMF’). For more info on KYC, RMF & Procedure to Lodge/ Redress Any Complaints, Visit dspim.com/ieidMutual Fund Investments are Subject to Market Risks, Read All Scheme Related Documents
