Commitment and endowment
as investor traps

Commitment effect and endowment effect 
in financial behavior

Some commitments or ownerships might enslave you, notably in
investment matters.

The commitment effect occurs when somebody takes a first move
in one direction and cannot stop going on even if it is a mistake.

The endowment effect (owner's syndrome) is when somebody gives
too much value to something it owns and does not accept any offer
to dispose of it.

incentive Careful, mental commitments and attachments
                are OK,
but some sneaky ones might trap and
                enslave you!
In life, commit commitments and attachments, to some people, to society
and to various things and practices, are essential

But they should not become unconsciously our prisons. so better avoid to
get  trapped into commitment biases / effects, or into endowment biases /
effects


The commitment effect and the endowment effect, each one has a
section below, are two common species of
behavioral biases by which
a person
limits mentally its
decision-making freedom.

Among other mind conditioning symptoms, those mental traps lead to:

* Anchoring, dogmas, unfounded habits or automaticity biases.
* In plain words, stubbornness
* In extreme cases, full mental slavery.

OK, a good thing is that the brain mental persistence found in such
narrow behaviors might help a person stay the course and not to float
aimlessly.
But the conditions are that the goals be respectable, the commitment
conscious, the moves not wild and the person's reason still in control.

Those conditions are easily missing. People who do not master their "sticky"
attitudes may go too far, get blind to anything else than their anchor and
are prone to  counterproductive decisions and behaviors.
Those biases affect notably many asset owners and
sousinvestors.
This area has been largely researched, thus this article digs into it to give
examples of those flaws.
Money always raise people interest, even academic interest ;-))

A) The commitment effect / trap / bias / bait

When you put a toe into the water,
the whole body might follow.

Definition

The commitment effect usually describes how a person who makes a first
small decision or move in some direction, can get unconsciously gradually
"trapped", via a series of other small decisions or moves, to go all the
way in that direction
.
The commitment sneaked into you,
paralyzing your ability to make independent decisions

This is the difference between
* a deliberate commitment
* and the commitment effect.
This trap can affect economic and financial investment decisions and
behaviors,
but also various other types of current or occasional human
decisions and actions.

The "first move" that triggers the trap

When somebody does something new, he / she often feels obliged
(committed), or at least is lazily resigned, to stick to that first
decision
, and to take other steps in the same direction, even if it is
a mistake.

People can bait themselves progressively that way.
But often, this "foot in the door" is  a 
manip manipulative  technique
used by other people.
Their trick is to convince or bait somebody into starting a task, or
doing a little thing, which consequences seem benign at a first
glance
.

The next moves (escalation)

The next step is when the person, not only does not go backwards if it
can, but feels obliged to
gradual gradually go further, and climb not only
the second step, but also the third, the fourth, and so on, and then the
whole staircase...

Not to "draw a line" make fall into this "escalation of commitment".

The most effort, hope, time, thinking and / or money somebody
"invests"
in doing something, the more that person feels committed to it,
gets obstinate up to the point of obsession.
It finds it painful
(here we have "cognitive dissonance") or at least hard
to get rid of this behavior even if things turn  bad.

This self-reinforcing phenomenon (positive feedback loop) creates a kind
of addiction and
dependence dependence or at least an habit and a rut.

How bad is that effect, and is there a way out?

Useful vs. dangerous traps

Among commitments, the best as well as the worst can happen.
We have to make a difference between:
  • A "normal" and conscious commitment:
During all their life, people have to take small and big
commitments, to choose sides and stick to some values

whatever the risks.
The contrary would be "commitment phobia", indecision,
passivity, lack of courage and pure opportunism.
To take voluntarily conscious commitments is crucial

in order to launch and execute projects, make things progress
and inspire trust.
  • A gradual commitment in positive habit-forming 
It leads then to routines felt necessary and beneficial.
Education for example creates commitments.
People brush their teeth because they were induced to do it
a first time.
It can also be a benign habit forming, not fully rational
nor questioned but with few consequences,
for example
buying our groceries most of the time in the same store
without making comparisons.
  • And the commitment trap, a highly risky behavioral bias
It starts with falsely benign actions and that makes us persevere
in irrational, addictive and counterproductive directions
.
From commitment to further commitment, it gets more and
more difficult to "draw the line" and escape
, until too
late.

This is like the famous frog in the water which temperature is
slowly raised until boiling point.
Also drug addiction starts with a first time.

A striking example was found in the Milgram experiment in
which the
players, committed progressively to obey an
authority,
took at the end potentially criminal decisions

How it works in financial investment

Beware not to put your money into a mousetrap!
  • The commitment effect has similarities with
the "endowment effect", another bias explained below.
It leads us to overvalue the assets we already own making
it
pain painful to kiss them good bye, as if they were our
own flesh.

Well, in the endowment effect there is some love for the asset,
while a commitment is a constraint, a pure bond. 
Also endowment refers mostly to economic assets while
commitment is found in most life situations.
  • In case a previous investment turns bad,
the habit to hold it might have created a kind of sentimental
"
loss aversion".
We are reluctant to admit we were wrong and thus to
accept to materialize the loss
, by getting rid
of the asset
for example.
This is one of the factors found in the so-called "prospect
theory"
.
  • A rather related phenomenon is the sunk-cost fallacy.
It is a biased "vested interest" rationale that incites, after having invested
in something that turned bad, to go on investing in it, with the purpose
to "get even".

The idea is
* that the former investment does not cost anything any more,
* at the same time (the thing is a bit schizoid) to try not to lose what has
   ben already invested, even if it is not realistic than it can be recovered

There is a lack of understanding that the loss is already done,
with ultra slim chances to change that fate, and running on the contrary
the risk to lose even more by investing more.

If we take a larger economic prospective approach, how many
businesses
became history, just because they stuck to their obsolete
past activities and / or
practices.

------------------------------------------------------------------------------------------
B) The endowment effect / trap / bias
      (owner's syndrome)

When our belongings are felt as parts of our heart,
to sell them is felt like selling our heart.

Definition

At the difference of the commitment effect, found in many life situations,
the endowment effect is mostly related to economic assets.
In some cases there is a relation with some other "possessive
emotions",  attachment biases" or "sentimental belongings".
To put it simply, the endowment effect / trap is a rather common feeling
among owners of economic assets
that they are gemworth more
than what the marketmarket offers.


Somebody who owns something, tends to give it a higher monetary
value than when he did not own it
.
Said even more simply, ownership increases value ...in the owner's
mind.

Investing and endowment effect

The separation drama

Many investors are reluctant to sell their financial assets whatever
the price offered,
as they feel that they are worth more than that price.
They also, ironically, overestimate it in comparison to the price they
would be ready to pay to acquire
those assets if they did not own
them.


That aspect of "what is mine is mine" is also called, the "divestiture
aversion"
, the "selling aversion", the "owner's syndrome" or, on
an even more affectionate
approach, the feeling "attachment bias".

Some similar phenomenon takes place when an investor, after
- reluctantly - selling an asset, rushes to buy another one, even
if the timing to do it is
wrong.

Emotionally, he feels amputated and he rushes to the transplant or
prosthesis store. He rationalizes his
fear fear by convincing
himself not to
"let the the money sleeping" and instead to own
again something that seems more "tangible" than just liquid assets.

Why this "conservative" attitude?

Why to behave like a financial hen's
protecting its financial chicks?


1) Status quo bias

Dislike for change


This tendency by people to overestimate what they have already, that
makes them prefer to keep it at all costs, goes further than the disposition
effect or loss aversion.
Those two other notions refer specifically to
a "reference priceprice"
(see reference point), on which a person
is
anchor  mentally anchored
(either what it considers a "good price", or a price above which it does
not lose money).


Actually, the selling aversion does not refer to such a preset price but is
more related to the status quo bias,
the general human reluctance
to change something in one's behavior,

2) Cognitive illusion

Without it, I would feel
poor poor, weak and naked.

To own an asset, or to invest in a venture, can give the illusion that it
makes you richer.
While to sell one / to divest makes you poorer, or at least put you into
a less safe position.


3) Emotional biases

feeling The pain of separation:
              no, I don't want to leave you!


This illusion is also half emotional, something related to hoarding, greed,
the fear of been deprived of something. In this sense, some people:
  • Either idealize or give a sentimental / affective value
to some assets (their family home...),
  • Or at least feel familiar with them
thus prefer them, whatever their real prospects, to the unknown,
This is linked to their fog uncertainty aversion /
risk attitude
  • Or, feel committed (see commitment) to what they already did,
making it hard to abandon it for a new venture.
  • They tend nostalgically to stay with their first choice,
to keep those first assets they got interested in
  • Or are afraid of change (see status quo bias).
  • Or are just ...lazy and see such a decision as a complication.
An endowment side effect: the harder to get 
something, the harder to leave it.

The price of sweat.

With their hard-earned money or belongings,
people tend to get overcautious.

This goes to the point of neglecting to take advantage of future gain
opportunities so as not to risk to lose.


Reciprocally, their heart is less attached to money that is not theirs or
that they got easily or by chance
With it, they usually take more
risks and initiatives (nouveau riche effect,
house money).

Source and further readings

See details in the Behavioral finance glossary
notably the commitment effect and endowment effect pages

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M.a.j. / updated
: 29 Aug. 2015

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