It is well known that once we own something, we are inclined to value it more than someone who doesn’t own it. This endowment effect is most at play when it comes to the housing market where homeowners systematically overestimate how much their house is worth in the eyes of a potential buyer.
But that endowment effect doesn’t always go in one direction. In fact, it tends to work only for assets that have increased in value. If we are confronted with losses, we tend to experience a “negative endowment effect” in the sense that something that has caused us pain in the form of losses seems worth less to us than to a more neutral outsider.
Take my recent experience with a new car we bought last year. I won’t mention the brand, but it was my first full-electric car, and I was proud to own it and thought it drove really well. For about seven months, both my wife and I were promoting the car to friends until one day, my wife had a catastrophic breakdown on her way to work. It had nothing to do with the battery or the electric drivetrain. Instead, a bearing on the rear axle broke, and essentially the car’s axle broke down completely. I will spare you the details of my arguments with the manufacturer and the garage, but the most likely thing that happened was that we bought a lemon with a one-off manufacturing flaw. But one thing I can assure you is that whenever I talk to my friends about my car these days, I make sure to tell them what a piece of crap it is and that I will never buy a car from that brand again.
Funnily, enough, something similar seems to work for assets that we own and that have made a profit or a loss. The chart below shows the beliefs about the quality of an asset in the eyes of people who own the asset vs. people who don’t own the asset and the return of the asset. As you can see, if the asset had a positive return, owners think that it is of higher quality than non-owners. But if the asset has a negative return, owners think it is worse than non-owners do.
Beliefs about the quality of a good
Source: Hartzmark et al. (2020)
According to the study, what happens is that once we own an asset, we are paying more attention to the news flow around that asset. I bet every reader will know more about the stocks they own and the recent company news around these stocks than about stocks they don’t own. But this focus on the news of assets we own creates a bias in our memory. The more we focus on news on specific assets, the easier it is to recall it from memory. And this recency effect of memory recall creates a tendency to extrapolate recent performance into the future. So, we start to be biased about our assets in a very systematic way and become “mental momentum investors” thinking that a streak of positive news has to continue as does a streak of recent negative news.
And how do you combat this kind of emerging bias due to ownership, you ask? I don’t really know. My experience as a practitioner is that one way to become less passionate and “invested” in an asset or a position is to pay less attention to it. This doesn’t mean ignoring it, but there is typically no need to follow the news on your stocks every day. If you are a long-term investor (e.g. you are saving for retirement or are a university endowment) then looking at the news flow every quarter as the company reports earnings etc. is probably enough. If you are a trader, then looking at the news flow on a daily basis is probably necessary. But what to do if you are a fund manager? My experience is that most fund managers are too obsessed with the day-to-day news flow and would be better served if they look at the news only once a week or so. This way you still get the key trends but are not distracted by the noise. And don’t worry, you will not miss the really important stuff. Because even if you don’t read the news at all, you can be sure that if something really important happens, people will alert you to it because they are getting scared. And being somewhat removed from the daily news flow will automatically allow you to remain calm and collected when others panic.