The Endowment Effect

The Emotions of Ownership

Think of your most prized possession. Now, imagine you decide you must sell this item. How much is it worth to you? How much would you charge for it? And would anyone else want to buy it at that price?

Let's consider the real-world example of a yard sale. Before your neighbors come to look at your things, you must first decide on the prices for them. For you, each item has a story, and some items may even evoke strong emotions. Let's say you're selling a pair of special edition sneakers that you took care of and really enjoyed wearing on special occasions. With these fond memories in mind, you put a price tag of $130 on the sneakers.

When a customer asks about them, you take time to share the story of how those sneakers were the best you've ever owned. The customer offers $50 for them. You think, "How could they not see how special and valuable these are?"

In financial transactions such as these, sellers often believe their own items are worth more than buyers are willing to pay. This occurs because buyers do not have the seller's experiences with and emotional attachment to the items. Buyers want a good deal, and even knowing the history behind an item does not mean they're willing to pay what the seller is asking for. This negotiation process can even feel a little painful for the seller—over losing something and the buyer not valuing it as much. Economists suggest this dynamic occurs through the endowment effect—people's tendency to value things they own more highly than they would if they did not own them. The endowment effect can take hold anytime we feel a sense of ownership over a product, and it can happen quickly. It can be a product that we simply pick up and contemplate purchasing, a product we bid on at a virtual auction, or even an item we are handed at no monetary cost.

The Endowment Effect for an Owner

Behavioral economist Dr. Dan Ariely highlights "three irrational quirks in our human nature" that come through when shopping for and purchasing items.¹ The first quirk is love. People fall in love with their possessions. These emotions go beyond the original purpose of buying a good. Some emotional connections and experiences are tied to it. You can develop an emotional connection to an item through the process of putting it together. The "IKEA Effect" (boxed insert) details the sense of pride and admiration people have for what they've accomplished after investing time and energy into putting an item together.

The second quirk is a sense of loss. Over time, the love people develop for things they own makes it harder to lose them—overpowering the thought of what they have to gain. For example, having a yard sale is an excellent way to de-clutter spaces and make some money at the same time. The feeling of gaining space and earning money should feel more exciting than selling smelly sneakers. The fact that someone wants to pay you less than what you think the shoes and memories are worth can be hard to accept. It might make you feel that you have more to lose than you have to gain by selling the shoes. Behavioral economists refer to this as loss aversion—people's tendency to place more emphasis on what they have to lose rather than on what they have to gain.² The emotion that goes with giving up an item weighs heavier on the heart than the feeling you had when you first acquired the item.

This brings us to the third quirk, which is assuming that a buyer will have the same emotional attachment to an item as the seller. Emotional attachment can develop through a person's experiences with an item, including the thought they put into purchasing it and, in some cases, the investment they made in customizing and maintaining it. Take, for example, a car. We spend a significant amount of time in them and often add our personal style to these spaces. This includes purchasing seat covers in a favorite style and color, but also doing the required repairs, researching the best tires, and putting our hard-earned money into making sure it runs well. A car seller may point out all of this, and the buyer may appreciate it, but that does not mean they will pay the asking price.

The Endowment Effect for a Buyer

Stores are filled with items that we imagine owning to add joy or value to our lives. Before anyone formerly researched and named the endowment effect, retailers realized the power of touch.³ Trying clothes on, pressing buttons, or getting to hold an item can impact purchasing decisions more than one may think. Doing these things can instill a sense of ownership before a shopper even pays for an item. Some businesses will even allow customers to try a product at a cost lower than the retail price, often for a trial period (say, 30-90 days) and with little to no risk.⁴ "No risk" often means a shopper can return an item for a full refund during the trial period. Giving customers a trial period helps them feel ownership, and it can sometimes translate to monthly or annual subscription purchases. (Think of the free trial period of your favorite television streaming service.)

Dan Ariely points out another ownership experience that he calls "virtual ownership" or partial ownership.⁵ Using the website eBay as an example, Ariely points out that shoppers can feel ownership of a product without even touching or owning it right away. Ariely's research has shown that this feeling causes people to bid higher and higher in online auctions. The emotional process of bidding on an item generates thoughts in the bidder: They imagine themselves owning and using the item. This idea of virtual ownership makes losing a bid hurt even more.

But I Paid So Much for It!

Now let's imagine having purchased a used car for $8,000. This car ran great for the first four months, but it had some significant problems and needed some expensive repairs after that. The car still has some issues that need to be worked out, but the mechanic said the repairs may cost more than the car is worth, so it may be time to replace the vehicle. The question is whether to keep the car or sell it. It is a difficult decision because, in addition to paying the $8,000 for the car, you also paid for several expensive repairs and cannot recover that money. This is a dilemma people face with other decisions, too, and it's known as sunk costs—costs that have already been incurred and cannot be recovered. Both the emotional and monetary investments people have in their items can make it harder for them to give something up. (This is loss aversion at work!) Emotions tend to cloud one's mind from making the best decision, as people may consider spending money on something where the costs outweigh the benefits. 

Overcoming the psychological obsession with sunk costs is possible. You can place less emphasis on past investments and more emphasis on moving forward, including focusing on the value of what you have to gain. Dan Ariely states that "throwing good money after bad adds wishful thinking." In other words, because you can't recover sunk costs, they should not enter into your current decisionmaking.

Conclusion

As the saying goes, "Emotions get the best of us." There is nothing wrong with being proud of owning things and treasuring your experiences with them. But when you consider selling a prized possession, think about whether you're fully ready to part ways with it. The past is the past, though, and focusing on what you cannot recover could possibly cause you to miss out on future possibilities. Removing your emotional attachment to material possessions can help you make more accurate assessments of how much your items are truly worth. If you decide to sell an item, realize that buyers will not consider the emotional investment you have made in the good. Rather, seek a price that satisfies both you as the seller and a potential buyer. Negotiation does require compromise.

The endowment effect is a concept that is important to both sellers and consumers. As a consumer, it is essential to keep in mind the value an item will add to your life before purchasing it. Spending involves making decisions and considering the opportunity cost—the value of the next-best alternative when a decision is made; it's what is given up. It's easy to feel a false sense of ownership or fear missing out by being outbid. But you have many choices, so be sure to consider what else you could do or experience with the money you are considering spending.