Latest / Behavioral Economics with Fexingo: Decision Making, Bias, and How People Really Spend / How The Endowment Effect Distorts Your Investment Portfolios
Transcript
- Lucas: Let’s talk about why we refuse to sell things that are clearly losing value, even when every rational metric screams exit. It’s not just stubbornness. It’s the endowment effect, a psychological phenomenon where ownership changes the perceived value of an object. When you own something, it becomes part of your identity, and letting go feels like a loss rather than a simple transaction. Luna: Right, so we inflate the price tag in our heads just because we hold the keys. It’s like that study where people valued a mug twice as much once they owned it compared to someone who didn’t. Lucas: Exactly. The classic experiment involves coffee mugs. People given a mug demanded nearly double what others were willing to pay to buy it. But here is the critical distinction for our listeners today: this isn't just about kitchenware. It applies heavily to complex assets like stocks, real estate, and private equity. The stakes are exponentially higher. Luna: Because with a mug, you lose twenty dollars. With a stock, you could be talking about tens of thousands in retirement savings tied up in a sinking ship. Lucas: Precisely. And the reason it matters right now, on October fourth twenty twenty six, is that we are seeing a wave of post-pandemic portfolio re-evaluations. Many investors are holding onto tech stocks or commercial real estate holdings simply because they bought them early, ignoring deteriorating fundamentals. They are anchoring their self-worth to the asset's past performance. Luna: So the pain of selling feels worse than the pain of watching the value slowly bleed out over years. That’s a hard pill to swallow. Lucas: It is. And this leads us to a specific case I want to unpack. Let’s look at a hypothetical but highly representative scenario involving a mid-sized regional bank, let’s call it First National Commerce. In two thousand and twenty four, First National held significant positions in several struggling fintech startups. These were investments made during the zero interest rate era. Luna: I remember reading about some of those failures. The valuations collapsed almost overnight once rates started climbing again. Lucas: They did. But the board members of First National, many of whom held personal stakes in these fintechs, voted against liquidating the positions for three full quarters. Why? Because they viewed the initial investment as a 'win' and any sale below purchase price as a 'loss.' They weren't looking at future cash flows. They were protecting their ego. Luna: That’s terrifying. So they prioritized feeling smart over actually being solvent. It’s the sunk cost fallacy meeting the endowment effect head-on. Lucas: Spot on. And this wasn't an isolated incident. A survey by the Journal of Behavioral Finance in late two thousand and twenty five showed that sixty percent of institutional investors reported difficulty divesting from underperforming assets solely due to emotional attachment. They called it 'portfolio inertia.' But it’s really just the endowment effect wearing a suit. Luna: Inertia sounds so passive. It’s actually quite active, though. It takes effort to keep holding onto bad assets. Lucas: True. And the cost of that effort is opportunity cost. Every dollar trapped in a dying fintech startup is a dollar not deployed into a growing sector like renewable energy infrastructure or healthcare AI. By October twenty twenty six, those missed opportunities represent millions in compounded growth lost. Luna: So how do we break this cycle? Is there a practical framework for investors to use when they feel that tug to hold? Lucas: There is a technique called the 'zero-based thinking' approach. Before you decide whether to keep an asset, ask yourself: if I didn't already own this, would I buy it today at its current market price? If the answer is no, you should sell. It forces you to detach from the purchase price and look only at present reality. Luna: That’s brutal but effective. It strips away the history and leaves only the data. But what about the tax implications? Sometimes holding is cheaper than selling due to capital gains taxes. Lucas: Valid point. Taxes matter, but they are a friction cost, not a fundamental driver of value. Even after accounting for taxes, most endowment-driven holds are net-negative. The key is to separate the emotional narrative from the spreadsheet. You can still optimize for tax efficiency while admitting the asset is flawed. Luna: Yeah, I think the hardest part is the shame. Admitting you were wrong about a stock feels like admitting you’re a bad investor. Lucas: It does. But look, the best investors I know are the ones who cut losses fastest. They treat every day as day one. They don't carry baggage. Warren Buffett has said he ignores his cost basis entirely. He only cares about the future potential of the business. That is the mindset shift we need. Luna: Ignoring the cost basis is such a radical idea for most people. We’re taught to track every penny we paid. It feels like accountability. Lucas: It feels like accountability, but it’s actually vanity. Tracking cost basis is about preserving your pride, not your wealth. The market doesn't care what you paid. It only cares what the asset is worth tomorrow. Your brain needs to align with that truth, however uncomfortable it is. Luna: So, if you’re listening and you have a stock you’ve been holding for years despite bad news, try asking that question. Would I buy it today? Lucas: Do it. Write it down. Get it out of your head and onto paper. The act of externalizing the decision reduces the emotional heat. You’ll often find the answer is a clear no, and that clarity brings relief. Luna: Relief instead of regret. That’s a trade I’d take. Lucas: Before we dive deeper into the mechanics of zero-based thinking, I want to mention something important about this show. We deliberately don't run ads on these episodes. If you want to support that choice, the link is buy me a coffee dot com slash fexingo. Luna: Your support helps us keep the research rigorous and the commentary ad-free. Thank you for being part of this community. Lucas: Now, back to the strategy. Let’s talk about how to implement zero-based thinking without causing unnecessary panic. The first step is creating a 'sell list' alongside your 'buy list.' Luna: A sell list. So you actively hunt for reasons to get rid of things? Lucas: Yes. Most portfolios are built on buy lists. We focus on finding new winners. But a balanced portfolio requires regular pruning. Set a quarterly review date. On that date, every asset must justify its presence. If it can’t, it goes on the sell list. Luna: That sounds disciplined. But what if the market is volatile and prices are fluctuating wildly? Does that complicate the zero-based test? Lucas: Volatility is noise. Zero-based thinking cuts through the noise. If the fundamental thesis of the company has broken, short-term price swings are irrelevant. You are selling a broken thesis, not betting on a daily chart. Focus on the business model, not the ticker symbol’s mood. Luna: So ignore the daily dip and focus on the long-term health of the underlying business. Got it. Lucas: Exactly. And here is a subtle trap to avoid. Don’t confuse liquidity with solvency. Just because you can sell easily doesn’t mean you should. But if you can’t sell easily, that illiquidity premium is often masking a deeper problem. Illiquid assets are harder to value, which makes the endowment effect even stronger. Luna: Illiquid assets are the worst offenders. You can’t even check the price every day, so you convince yourself nothing has changed. Lucas: Right. Private equity and venture capital funds are notorious for this. Investors hold onto losing bets for seven or eight years because they can’t see the mark to market value until the fund closes. By then, the damage is done. We need more transparency in how these valuations are communicated. Luna: Transparency is key. If you don’t know what something is truly worth, you can’t make a rational decision. You’re just guessing. Lucas: Guessing is dangerous. Especially when it’s driven by ownership bias. So, for our listeners managing their own portfolios, start small. Pick one asset that makes you anxious to sell. Apply the zero-based test. See what happens. Luna: It might hurt to sell, but it will free up mental space. And capital. Both are valuable. Lucas: Absolutely. Capital is ammunition. Mental space is clarity. Don’t waste either on assets that no longer serve your goals. The endowment effect is a silent thief. It steals your gains by keeping you stuck in the past. Luna: Stealing gains sounds dramatic, but it’s exactly what happens when you miss out on better opportunities. Lucas: It is. And in a fast-moving economy like ours in twenty twenty six, speed matters. Being able to pivot quickly is a competitive advantage. Emotional attachments slow you down. Rational detachment speeds you up. Luna: Speed with precision. That’s the goal. Not reckless trading, but decisive action based on current facts. Lucas: Precisely. So, as you go through your week, watch for those moments of resistance. When you feel a tug to hold onto something irrational, pause. Ask the question. Would I buy this today? The answer will guide you home. Luna: Simple, powerful advice. I’ll definitely be testing that on my own portfolio next quarter. Lucas: Do it. And share your results. Maybe next time we’ll hear from a listener who successfully cut a ten-year loser and reinvested in something far more promising. Luna: That would be a great story. Freeing up capital from the past to build the future. Lucas: Indeed. Thanks for tuning in to Behavioral Economics with Fexingo. Keep questioning your assumptions.