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How Thinking
Affects Investing

Endowment Effect

The ENDOWMENT AFFECT, sometimes called OWNERSHIP BIAS, dictates that when we own something, we place a higher value on it than we would if we didn't own it.

It is the endowment effect that is, in large part, responsible for so many of the useless objects that clutter people's homes. Once we own something, it can be difficult to throw it out or give it away, even if we don't really need it. (How much easier it is to not acquire such objects in the first place!) On the other hand, it is easy to go through someone else's belongings and point out all the unnecessary junk.

The endowment effect is particularly strong when we buy and sell stocks. Consider the following example.

Person A owns $1,000 worth of stock in the XYZ Company. Person B has no stock, but he has $1,000 in cash. Person A and Person B discuss the merits of XYZ and come to the conclusion, together, that, right now, holding stock in the company would be a bad investment. There are better ways for each of them to use $1,000.

If you are Person B, you, will find it easy to not use your $1,000 to buy XYZ stock. After all, you have just decided it is a poor investment.

If you are Person A, however, you will find it much more difficult to sell your $1,000 worth of stock. Why? Because you already own the stock.

Because of the endowment effect, the stocks you own seem more valuable than they would if you didn't own them, which makes them all the more difficult to sell.

Harley's Rule of Investing #4

The stock doesn't care who owns it.

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