About Endowment Effect

According to Wikipedia, Endowment Effect is a theory when people value the things that they have higher than the things that they don't have. It is direct opposite of standard economy theory when willingness to pay should equal to willingness to accept. To put it simpler, let's say that you have 5 pearls which you bought for 100 dollars each on five years ago. In the next five years however, its price has rise to 500 dollars each. The question is, what will you do to the pearls? Endowment effects is the things that make you keep the pearls because you thought that the pearls are worth more than 500 dollars each. In other words, you have put higher value to your pearls than what they should be.

George Lowenstein and Daniel Kahneman from "Explaining the Endowment Effect" said that endowment effect could be caused by disappointment that may occurred when we trade our assets with other assets, or the affection you have on your assets. For example, no matter what happen to your hometown football team, you will cheer on them or even bet for them. If it happen on your investment policy, it is called endowment effect.

Then what's the connection with investment world? In investment context, endowment effect could have high contribution in deciding your investment plans. Those who have endowment effect will stay still on their investment plan no matter what. The important thing is, the effect will destroy the balance between your investment goals and your investment instrument. For example, you are a young people with high stress tolerance, bravery, and supported with high income, some would say that stock market is the one for you. However, since you are already familiar with debenture, which relatively more secured than stock and lower repayment rate, you still choose debenture as your investment instrument and lose your chance to gain more from stock market. The point is, go way back into your investment goal and analyze the potential and risk tolerance of yourself before deciding your investment instrument. Knowledge about instrument is not a good reason to quit because it could be gain anywhere and if you are serious about your investment plan, you have to take your time to study thoroughly about many option available for you.