Home > Personal Finance > The High Cost of Being Sentimental

Comments 0 Comments

Wasting time recently on a discussion board for rabid sports fans, my eyes stopped on a phrase that shocked me: “endowment effect.” Dropped casually in among the emotional discussion of who’s the best offensive or defensive player was a high-fallutin’ term from economics. I thought it out of place for a moment, but quickly realized I was wrong. Message board combatants were arguing about a trade, and one of the fans was correctly accusing the other of overvaluing the player from his team that he proposed in the trade. I believe his precise words were, “You’re crazy! I’m not giving you (my star player) for (your scrub player).”

This is a classic example of the endowment effect in action. Understanding this effect could save you a lot of money. Or at least prevent you from making some bad trades.

Even if you’ve never heard of the endowment effect, it probably comes up in your own life nearly every day. The endowment effect makes selling a home unnecessarily heartbreaking. It often makes you overpay for things. I believe it keeps you paying for name-brand products even after they are obviously inferior or more expensive than lesser-known alternatives. Once you understand the endowment effect, you can notice it popping up in your own life, and then make some changes.

Sentimental Value vs. Market Value

Economist Richard Thaler coined the term back in 1980. It means simply this: You overvalue things you own because you become attached to them. They become part of your psychological endowment. If you try to sell them, you demand a price that is higher than you would pay if you were looking to buy that same thing. This gap between sale price and purchase price is the cause of a lot of unnecessary struggle in the marketplace.  For example: Take that beat up 1984 Ford Mustang convertible in your garage (and by your garage, I mean my garage). If you try to sell it on Craigslist, you might demand $1,500 for it, subconsciously because you remember all those fun rides with your dog sitting in the back seat, and because you believe it runs better than it looks. But if you were to go out looking to buy that very car, you wouldn’t pay any more than $600 for it. (Look at the rips in the convertible roof!)

Thaler’s classic experiment, oft repeated, involves handing coffee mugs out to college students and asking that they sell them to other students. Sellers asked for around $7; buyers only wanted to pay around $3. The roughly 2.5-1 ratio has held in many subsequent tests. Once you own something, it becomes part of your endowment, which means you tack on extra value to it that represents the “cost” of losing it. Before you had it, there would be no cost for losing. Buyers feel no reason to pay this cost. They are buyers, not therapists! They aren’t going to pay for your separation anxiety.

What Was, What Could Have Been…

Back to sports for one moment. Fans love proposing trades, but they rarely make sense, because they can’t help overvaluing a player on their team who they’ve seen every day for a few years.  They remember the all-star season three years ago, and expect a star in return, when everyone else sees the player as a has-been worthy of only a late-round draft pick.

The endowment effect has other names — or more precisely, it describes a phenomenon that’s been observed as “status quo bias” or “loss aversion,” which are exactly what they sound like.

You can most obviously imagine the impact of these habits if you think about selling your home. I believe endowment effect contributed to the painful length of the housing downturn, as sellers couldn’t help thinking “But John down the block sold his house last year for $500,000! I’m not taking a penny less than that,” while their houses sat and sat and sat on the market. (That example also describes anchoring, a behavioral trick we’ll discuss in a future column).  But loss aversion shows up in more subtle ways on a daily basis.  For example: Inexperienced traders nearly always have trouble selling stocks and funds at a loss, even when it seems certain losses will steepen, because they can’t help themselves from imagining, “I paid $30 a share for this stock, I can’t sell until it goes back up to $30 a share.”

There are far more everyday examples. Stores play with consumers’ heartstrings all the time by convincing them that a certain discount for an item is temporary.  Shoppers report buying an item out of fear that they might lose it, or the sale price, more than out of need for the item — panic buying. That’s loss aversion marketing at its finest. One way to think about it: shoppers who already have tried on a shirt, or are holding a guitar, almost immediately feel ownership of the thing in their hands, and now will experience a loss if they put it back on a shelf. Items can become part of your psychological endowment almost instantly.

Loss aversion in general might be the easiest concept to understand. Consumers hate losing $100 much more than they hate missing the potential to earn $100, though ideally we’d value these things equally. Numerous studies have shown this impact: a gambler who has just lost $100 is much more likely to make a second bet (and attempt to recoup the loss) than a gambler who has just won $100. But here’s another example: Workers who are told they might earn a bonus of $100 by working hard this week DON’T work as hard as workers who are told they WILL get a $100 bonus, but they might lose it if they don’t work hard. Or one more example:  Consumers get much more angry when stores position a price change as an increase rather than the end of a discount, even if the amounts are the same. At a gas station, you will never see a credit card penalty; you’ll see a cash discount.

Letting Go

This same phenomenon, albeit more subtle, helps nudge consumers towards paying extra for brands they know. What is a brand except an excuse to charge extra for a perceived value that is lost when a consumer switches? If this weren’t true, Advil would never be able to charge a 25-50& premium over generic ibuprofen.

All these irrational behaviors lead to wrong-headed decision making. People overpay to stick with products they know, and they undervalue the potential gain of taking a risk on a new brand of cereal, or a new bike, a car. This is why auto insurance companies can undercut each other when trying to convince you to switch policies; they can overcharge loyal customers.

Endowment effect isn’t the only force at play in these transactions – simple habits explain a lot. But understanding why you excessively value things you have or know will help you pay less in nearly every transaction you make.  And it’ll probably help you (and me) say goodbye to that old clunker in the garage.

More Money-Saving Reads:

Image: iStock

Comments on articles and responses to those comments are not provided or commissioned by a bank advertiser. Responses have not been reviewed, approved or otherwise endorsed by a bank advertiser. It is not a bank advertiser's responsibility to ensure all posts and/or questions are answered.

Please note that our comments are moderated, so it may take a little time before you see them on the page. Thanks for your patience.

Certain credit cards and other financial products mentioned in this and other articles on Credit.com News & Advice may also be offered through Credit.com product pages, and Credit.com will be compensated if our users apply for and ultimately sign up for any of these cards or products. However, this relationship does not result in any preferential editorial treatment.

Hello, Reader!

Thanks for checking out Credit.com. We hope you find the site and the journalism we produce useful. We wanted to take some time to tell you a bit about ourselves.

Our People

The Credit.com editorial team is staffed by a team of editors and reporters, each with many years of financial reporting experience. We’ve worked for places like the New York Times, American Banker, Frontline, TheStreet.com, Business Insider, ABC News, NBC News, CNBC and many others. We also employ a few freelancers and more than 50 contributors (these are typically subject matter experts from the worlds of finance, academia, politics, business and elsewhere).

Our Reporting

We take great pains to ensure that the articles, video and graphics you see on Credit.com are thoroughly reported and fact-checked. Each story is read by two separate editors, and we adhere to the highest editorial standards. We’re not perfect, however, and if you see something that you think is wrong, please email us at editorial team [at] credit [dot] com,

The Credit.com editorial team is committed to providing our readers and viewers with sound, well-reported and understandable information designed to inform and empower. We won’t tell you what to do. We will, however, do our best to explain the consequences of various actions, thereby arming you with the information you need to make decisions that are in your best interests. We also write about things relating to money and finance we think are interesting and want to share.

In addition to appearing on Credit.com, our articles are syndicated to dozens of other news sites. We have more than 100 partners, including MSN, ABC News, CBS News, Yahoo, Marketwatch, Scripps, Money Magazine and many others. This network operates similarly to the Associated Press or Reuters, except we focus almost exclusively on issues relating to personal finance. These are not advertorial or paid placements, rather we provide these articles to our partners in most cases for free. These relationships create more awareness of Credit.com in general and they result in more traffic to us as well.

Our Business Model

Credit.com’s journalism is largely supported by an e-commerce business model. Rather than rely on revenue from display ad impressions, Credit.com maintains a financial marketplace separate from its editorial pages. When someone navigates to those pages, and applies for a credit card, for example, Credit.com will get paid what is essentially a finder’s fee if that person ends up getting the card. That doesn’t mean, however, that our editorial decisions are informed by the products available in our marketplace. The editorial team chooses what to write about and how to write about it independently of the decisions and priorities of the business side of the company. In fact, we maintain a strict and important firewall between the editorial and business departments. Our mission as journalists is to serve the reader, not the advertiser. In that sense, we are no different from any other news organization that is supported by ad revenue.

Visitors to Credit.com are also able to register for a free Credit.com account, which gives them access to a tool called The Credit Report Card. This tool provides users with two free credit scores and a breakdown of the information in their Experian credit report, updated twice monthly. Again, this tool is entirely free, and we mention that frequently in our articles, because we think that it’s a good thing for users to have access to data like this. Separate from its educational value, there is also a business angle to the Credit Report Card. Registered users can be matched with products and services for which they are most likely to qualify. In other words, if you register and you find that your credit is less than stellar, Credit.com won’t recommend a high-end platinum credit card that requires an excellent credit score You’d likely get rejected, and that’s no good for you or Credit.com. You’d be no closer to getting a product you need, there’d be a wasted inquiry on your credit report, and Credit.com wouldn’t get paid. These are essentially what are commonly referred to as "targeted ads" in the world of the Internet. Despite all of this, however, even if you never apply for any product, the Credit Report Card will remain free, and none of this will impact how the editorial team reports on credit and credit scores.

Our Owners

Credit.com is owned by Progrexion Holdings Inc. which is the owner and administrator of a number of business related to credit and credit repair, including CreditRepair.com, and eFolks. In addition, Progrexion also provides services to Lexington Law Firm as a third party provider. Despite being owned by Progrexion, it is not the role of the Credit.com editorial team to advocate the use of the company’s other services. In articles, reporters may mention credit repair as an option, for example, but we’ll also be sure to note the various alternatives to that service. Furthermore, you may see ads for credit repair services on Credit.com, but the editorial team isn’t responsible for the creation or implementation of those ads, anymore than reporters for the New York Times or Washington Post are responsible for the ads on their sites.

Your Stories

Lastly, much of what we do is informed by our own experiences as well as the experiences of our readers. We want to tell your stories if you’re interested in sharing them. Please email us at story ideas [at] credit [dot] com with ideas or visit us on Facebook or Twitter.

Thanks for stopping by.

- The Credit.com Editorial Team