Budgeting/Work/Life Balance

What The “Endowment Effect” Is, & How It Might Be Ruining Your Finances

By | Wednesday, July 25, 2018

Why, when we get into a financial hole, do we sometimes keep digging? Why is it so hard to resist the siren song of an item that wasn’t even on the radar before we came across it in a store? It might be because of a phenomenon known, in behavioral economics, as the “endowment effect.”

A term coined by the Nobel Prize-winning economist Richard Thaler, the endowment effect is the idea that people assign more value to things they own than those they don’t — even if those items are actually identical or don’t have any inherent value. This behavior might also be unintentionally sabotaging your budget. However, by understanding the endowment effect and how marketers and companies use it to get you to part with your money, you can have a few tricks in your back pocket to help you avoid common pitfalls.

Before it even had a name, companies understood that if they could make shoppers feel ownership for an item right there in the store, they were much more likely to buy it. Thus the invention of fitting rooms, showrooms designed to look like a living room or bedroom, or free trial periods where you can take the item home and “live” with it for a while, seemingly risk-free. All of these strategies ensure that a shopper becomes emotionally attached to an item — often unconsciously — and is then willing to part with their money for it, even if it was originally outside their budget or they didn’t have a need or want for it when they first walked into the store.

Even in the absence of a physical item, the endowment effect might still be in play. For example, you sign up for a free trial of a music streaming service that you have every intention of canceling once the trial period ends. It lets you build playlists, offers suggestions, and gives you the option to customize your listening style as much as you want. It begins to feel like your little personal radio station, at your fingertips whenever you need it, filling a need you didn’t know you had. Suddenly, that extra $15 a month seems totally worth it and you don’t cancel the subscription after all — that’s the endowment effect at work.

Maybe you’re really good about canceling services once the free trial period is up. You only use the free version of Spotify and you’d never pay for cable. But your file backup system, which worked fine when all you were putting on it was a few word documents, is suddenly almost full of pictures and video from your phone. You decide to upgrade to the paid version instead of doing research on other free options or pricing out competitors. You already know the interface and you were comfortable with the free version, so you’re willing to pay for the next level of service so you can keep backing up your phone, uninterrupted. That’s the company banking on your submission to the endowment effect.

This effect extends beyond simply buying things, too. Ever heard the phrase “Better the devil you know than the devil you don’t?” It makes you think, for example, that staying in a bad job is better than looking for a new one because with the current situation at least you know what to expect, even if it can be summed up as “not great.” Keeping an unreliable car and paying for repairs every few months is easier than saving up for another one and going through the hell that is car shopping. Even maintaining toxic friendships or staying in a bad romantic relationship because somehow doing nothing seems easier than doing anything can be attributed to the endowment effect.

At this point, you might be tempted to throw up your hands and fork over all your money. Can’t go against human nature, right? Well, here are some tips to try instead. First, before you go into a store or sign up for a free trial, write down your budget and the maximum you’re willing to pay for an item or service. Having it in writing, perhaps taped to your credit card on a brightly colored post-it note, might help you stick to a budget no matter how much you like something once you’re out shopping. Then, when you’re ready to pull the trigger, stop for a minute and really think. Is this item or service truly worth your hard-earned money? Do you value it more than the hours of your life you’re trading for it? If the answer to all of these questions is yes, then, by all means, go for it. If not, walk out of the store, close the browser window, or delete your payment information. Sleep on it. See how you feel in the clear light of dawn.

Think about the advice you would give a friend in your situation. Be kind, but objective. Finally, make a pro/con list about the job, relationship, or otherwise non-ideal situation. Give yourself a deadline by which you must make a final decision, even if that decision is “I’m sticking with my crazy boss because I love the industry and there’s room for growth at this company.” Once you’re able to remove emotion from the equation, you’ll have a much more rational view of the situation and be able to make a decision based on facts.

The endowment effect isn’t all bad. It helps us take care of our things, maintain relationships through peaks and valleys, and get a spark of joy when we buy something we really wanted and wear it for the first time. As long as we are aware of how it might affect our finances and be used against us, we can be savvy consumers — ones who have a firm handle on our emotions and our budgets.

A grant writer by day and personal finance fanatic by night, Marisa is an avid traveler who lives in Pittsburgh, PA. When she’s not reading or writing for work or play, she enjoys running, thrifting, and searching for the most authentic Mexican food in the city.

Image via Pexels

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