Beat the 'Endowment Effect'


First theorized by Richard Thaler almost 30 years ago and supported by many experiments, the endowment effect shows that people believe something they own is worth more than the exact same thing they don't. What it means for those who need extra money in a poor economy is that they may end up hurting their finances unless they come to terms with the endowment effect.

An example of the endowment effect is housing prices. Many homeowners feel the value of their house is worth a certain amount and set the price to reflect this, but with the current economic turmoil and falling housing prices, the price is higher than what buyers are willing to pay. Prospective buyers simply shake their heads and move on to the next property.

Everyone wants to get paid for what their stuff is worth. But be careful of the endowment effect, which can have the following negative consequences.

You sell later than you should: An item loses value over time, with the exception of collectibles. If you realize you don't need something, selling it immediately will put more money in your wallet. The endowment effect encourages you to wait longer to try and get a better price. When it comes to a house, even a few months can mean thousands of dollars lost.

You keep too much junk: If you have a lot of junk lying around the house, it's possible you aren't willing to get rid of it because of the endowment effect. The items end up sitting in your house even though you won't ever use them again. The longer you hold on to them, the greater the likelihood you will throw them out or give them away.

You drive away potential buyers: By initially pricing things too high, you end up driving away potential buyers. Again, the price of the home is a perfect example. If a home is priced too high for a certain area, people won't even come to look. Even if the price is lowered later on, a house languishing on the open market for a long time is viewed as a negative. The fewer the people who are interested, the greater the chance you will end up selling it for less.

Opportunity cost: Most people never take into consideration the opportunity cost they lose when they end up not selling an item. For example, if the seller feels the item is worth $150, but all similar items are selling for $100, the seller may decide to keep the item until prices rise back up to $150. That may never happen, meaning the seller gets nothing for it and loses the $100. If he eventually does sell the item for his $150 price, it will likely be years down the road after the economy has recovered, but even then he is likely to have lost money.

Say the seller was able to sell the item for $150 five years from now. That would seem to be a $50 profit, and he was smart to have waited, but if that $100 could have immediately gone to pay down debt on a credit card with a 22% interest rate, that $100 is worth nearly $300 today rather than five years from now.

Understanding that the endowment effect is something that can greatly hurt you is important to being financially savvy. Learn to sell things as soon as you know they are no longer going to be used, even if you only can get a small amount. In the majority of cases, doing this will have you come out ahead in the long run.

When you are putting something up for sale, don't go by what you think something is worth, but research what similar items are actually selling for on the used market. A handy tool for this is the eBay (Stock Quote: EBAY) sold-items option, which will show what price items have sold for over the past month. By looking at hard data instead of going by your feelings, you are likely to sell your stuff quicker and for a higher price.




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