Maybe it’s time for some financial KonMari.
The recent popularity of a hit Netflix series, Tidying Up with Marie Kondo, has been a sobering reminder for me: I’m not good at cleaning out! I know that I have no practical use for my college fraternity shirts, for example, but they’re hard to let go of. Maybe I’ll be in dire need of a t-shirt blanket sometime in the future? I’m inclined to keep them, “just in case.”
The fact is, I’m a victim of the endowment effect — valuing something I already own more than I value something I don’t own yet. Old t-shirts feel important to me, but if someone offered to sell me those same t-shirts, I would not be interested. I don’t fall in love with every t-shirt I see for sale in gift shops when I’m on vacation. So, I know that my perceived value of the shirts exists merely because I already own them.
A related, helpful term is sunk cost — a cost that has already been incurred and cannot be recovered. Sunk costs are, therefore, not relevant to decision-making in the present or future.
This past weekend, the SR Wife and I drove to a state park where we intended to go hiking. When we got there, we learned that the trail we planned to explore had been closed. At that point, we were disappointed, but the time and gas money we had already spent driving to the park were sunk costs. They could not be recovered. Therefore, they were not relevant to our decision of what to do next!
We ended up staying to have a picnic lunch and hammock by the lake, and we had a nice time (see the feature photo background above).
If we’re not careful, the endowment effect and sunk cost bias can be seen in areas with higher stakes. Consider the below examples.
Are you keeping your old car because you’ve spent a lot of money on maintaining it — even though it is likely to break down again soon? The money you’ve already spent on maintaining the car is a sunk cost. Ideally, you should only consider the car’s current value and related possible future costs in your evaluation.
Are you planning to turn your current home into a rental property when you move out of town for your new job? Consider if you really want to own a rental home in that location. Or, is the endowment effect causing you to over-value your home only because you already own it?
If you had the cash value in your checking account today, would you make the decision to purchase that car or home again? If not, you too are a victim of the endowment effect and sunk cost bias!
Worse still, are you staying with a high-cost financial advisor just because that’s where your investments are now? Get out of there!
We can all be affected by biases in our decision-making. But, by recognizing that the biases exist, we can reduce their impact on our lives. That’s also why it’s essential to identify what’s most important to you in life and pursue those things intentionally.
What financial clutter do you have in your life? Maybe it’s time to cleanout. Don’t let endowment effect or sunk cost bias convince you otherwise.