If you're one of the lucky guys who got a mug, for how much would you sell it? Remember, they sell them at any time at the cafeteria for $6. Think for a second and write down the number.
Now switch hats. Suppose that you did not receive a mug. How much will you be willing to pay one of your peers to buy his or her mug?
Let's look at these numbers - it makes sense that the average selling price and the average buying price will be the same. After all, they both represent the value that people associate with the mug. Why would people who have a mug associate a different value than people who don't? If at all, people who have the mug should price it low - since the only way they can convert it to cash is through undercutting the cafeteria.
Turns out this is not the case.
In a similar experiment done a few years ago, mug owners were willing to sell it for an average of $5.75. In other words, they, on average, assigned the value of $5.75 to the mug they just got. However, people who don't own the mug were, on average, willing to pay only $3.25. In other words, they assigned a much lower value. Somehow, owning the stupid mug increased its value in the eyes of the owners, even though they had owned it only for a few minutes and hadn't had time to develop any deep feelings. This makes no sense.
I can recognize this from my behavior. I wouldn't buy an old broken iron for a buck, but when I had one, I didn't want to sell it for less than $20 (I ended up donating it.) There are clothes that I have in the closet that I wouldn't buy now even if they were virtually free, but wouldn't get rid of now that I have them. Why is owning
something makes us assign a higher value to it?
Behavioral economists have found this phenomenon to be consistent: a sense of entitlement, or ownership, will raise the value of whatever you have. You won't buy an old clunker for $5,000, but you'll certainly not sell your clunker for less than $8,000. In a restaurant, you won't eat a salty overcooked lukewarm bowl of soup, but if you made it, you won't throw it away and finish it all. If you get a ticket to a show that has a $100 list price you'd rather go and watch the show even if you don't like the band, instead of giving it away or selling it for the $5 it's actually worth to you.
People associate a different, higher value to items that they own. We get attached too easily to what's ours. We also have the tendency to use our cost to estimate the value. This can be especially bad when it comes to investments.
You bought 1000 Microsoft shares for $40 a piece. Now the stock trades for $25 a share. Do you hold? Do you sell? Do you buy more? How much is the stock worth to you?
The objective truth is that the stock is worth $25, no matter how much you paid for it (except for tax purposes, which we'll neglect for the sake of this discussion.) But perhaps you feel deep inside that the stock is worth $40, and you need to wait until the market realizes that it owes you $15 a share and correct its mistake. It is as silly as it sounds, but we all do it.
It's difficult to get over this. One way of coping is to go through the following mental exercise: your shares are worth $25,000. Suppose you sell them and now you have $25,000 in cash. Would you invest it in Microsoft given the current stock price, or invest it elsewhere? If the answer is "elsewhere", sell. If the answer is "Microsoft", hold.
And if you're not sure?
In that case, perhaps you should do what the experts do and switch to index funds.
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