Endowment Bias is Real

One of the early chapters of CFA Level III is on Behavioural Finance, in which a number of biases that affect investors and investment decision-making are covered. Some of these biases seem quite similar to each other and may even be known by different terms to different people, but here’s a quick summary that I had to study for anyway:

• Cognitive Errors
  • Belief Perseverance Biases
    • Conservatism Bias
    • Confirmation Bias
    • Representativeness Bias
    • Illusion of Control Bias
    • Hindsight Bias
  • Information Processing Biases
    • Anchoring and Adjustment Bias
    • Mental Accounting Bias
    • Framing Bias
    • Availability Bias
• Emotional Biases
  • (Emotional Biases)
    • Loss-Aversion Bias
    • Overconfidence Bias / Illusion of Knowledge Bias
      • Self-Attribution Bias
      • Prediction Overconfidence
      • Certainty Overconfidence
    • Self-Control Bias
    • Status Quo Bias / Inertia Bias
    • Endowment Bias
    • Regret-Aversion Bias

So I’m here to write about endowment bias in particular, because it is one thing to study it in theory and analyse a scenario to recognise the bias, and quite another thing to actually experience it and want to take actual steps to mitigate its impact.

Simply put, the impact that endowment bias has on an investor causes him to place a higher valuation on an investment that he owns as compared to one that he doesn’t, all else being equal. This is quite prevalent across the many people that I speak with. For example, many people on a property hunt in Singapore complain that property prices are way too expensive, and yet they will never consider selling their own property cheaply or at a loss. This is likely further exacerbated by the meticulous interior design and extensive renovation to ensure that their unit is a home (to them) and not a house.

So why am I bringing up this particular bias right now? We have recently spoken with a financial advisor to do some forward-planning on our assets, in view of pursuing our property portfolio and business expansion plans. Amongst the many recommendations that he provided, one of them stood on how to deal with my existing investments in US and SG stocks, ETFs, and robo-advisors. His view is that I’m spreading myself too thin with little diversification benefit, and would be better off liquidating my investments, and consolidating them into a well-diversified unit trust or an ETF instead.

There is some value to that advice, as I can minimise transaction costs and need not focus so much on stock-picking and keeping track of my investments while it gets good reasonable returns that is slightly above inflation (of course there will still be the fair share of volatility and potential for not getting back my capital).

But there is a part of me (the endowment bias part) that feels so sayang at having to liquidate everything that I have painfully tracked since 2016, from time-weighted returns to dividends and even corporate actions. At this point, one online nugget that I recently picked up (can’t remember from where…) might be useful for me to remember:

You can remember the stock you own and even when you bought it, but the stock never remembers who its owner is.

Anonymous

This reminder is important for me to acknowledge that I should just do what’s best for my financial situation. One final thing that I picked up from CFA just to round up how I have to deal with this endowment bias: Emotional biases stem from feelings or impulses or intuition and as a spontaneous reaction, which are more difficult to overcome even with education and may have to be accommodated in some cases.

To be honest, I’m still not fully bought into the idea and might eventually do a hybrid solution instead – liquidate some, while leaving the rest untouched. But as I ponder about my next steps, I must take note of all these biases lurking in the corner as I make my investment decisions.