As human beings, most of us have a hard time letting go, especially in cases where we have held something for a long time and formed a personal attachment to it. From the treasured (blue) coffee mug, to the t-shirt we got at that concert, to the higher-stakes situations like the family home we’ve lived in for years, or the company stock we’ve built up over decades that made it possible to retire. The good news is that our human tendency to create attachment enables us to invest into ourselves and our community. The bad news is that it can create a resistance to change. Such an unwillingness to sell is especially problematic in situations like real estate or concentrated stock positions, which create real financial planning hazards that advisors must help their clients navigate.
In this guest post, Dr. Meghaan Lurtz, a leading expert on the psychology of financial planning and Professor of Practice at Kansas State University, explores the research behind this phenomenon (known formally as the “endowment effect”), how it typically manifests in financial planning situations with clients, and more importantly what financial advisors can actually do to help their clients get more comfortable with selling an asset that needs to be sold.
The endowment effect is complicated, though, because it’s actually driven by three different mechanisms, any one of which (or sometimes a combination thereof) may be at play in any particular situation. In some cases, it’s driven by loss aversion – the recognition that the pain of loss is twice as impactful as the joy of a comparable gain, which causes us to ask a lot more when selling something than we would ever pay to buy it. In other cases, our own identity gets tangled up into the situation… such as the concentrated stock position that was accumulated through years of employment, making it more difficult to sell since we feel that we earned it through the fruits of our labor and our success as a career professional. And sometimes, it’s simply a result of different anchor points between buyers and sellers: when we’re asked to let go we often think of the highest price it could be worth (e.g., what the most expensive property on the street ever sold for), while the buyer looks at how inexpensively it might be obtained (e.g., what the least expensive property in the area went for).
