Endowment Effect

Love on the Rocks

She had been on my radar for weeks, maybe months.  I did a full background check and stalked her daily moves.  She sported an hour glass balance sheet, voluptuous free cash flow and a head-turning chart.  And with the ticker HOT, I figured it was destiny.  Our liaison commenced.   

Fast forward 6 months.  Her balance sheet is a snowman, the cash flow was a push-up and I read the chart upside down.  My once investment darling now looks like post-Nirvana Courtney Love.  Gripped with a debilitating case of Coyote Arm, I wondered what I could do to divorce myself from this pickle.  I thought I did my 411; all boxes were checked and the timing seemed oh-so-right.  Instead, I got catfished. 

So, what are my options?  What did I miss? Any of us that have invested long enough know that mistakes are inevitable.  If you’ve been immune, you simply have been parked in money markets and CD’s or you may have a bad case of Fonzi-itis.  The best investors are apathetic about their stocks.   It’s nothing personal – they move on pretty quickly if things aren’t working out.   They may use sell-stops or simply pull the plug if they think the story & facts have shifted.  Everyone has a right to change their minds.   

Like a stubborn 15 lbs. it’s something I constantly grind at.  Must of us suffer from a few, financial behavioral warts.  I know I beat this drum - perhaps a bit too often – but I contend investment results suffer from not so much crummy selections but impish conduct.  There are multiple behavior biases but one of the most ruinous is the Endowment Effect.  

The Endowment Effect (we’ll call it ED) makes us consider our personal assets more valuable.  Any realtor can confirm this.   Doesn’t matter if it’s our homes, cars, clothing or investments; I own it so therefore it’s premium priced - we need to justify our love.  Never mind what the market place dictates, I know better.  Wanna really kick ED, go hang out on Craig’s List for a week or 2.  Just make sure to meet in well-lit, public settings.     

ED can be a real killer on portfolio returns.  Buy and hold morphs into buy & die.  Paper cuts fester into amputations.  Most diversified portfolios will have ample winners; it’s how we handle the losers that determine long term success.  Losses inflict more pain, proportionately, than a winner’s sensation.    Simple math in the chart below depicts the cruel relationship between losses and gains (and time) needed to break even.  For example: a loss of 25% would require +33% or 2.2 years of 14% gains.

Financial markets are fast moving, dynamic and, at times, certainly baffling.  Today’s Bitcoin could be tomorrow’s Plutonium.  I’ve learned dating a stock is an emotional guardrail versus marriage.  I also tested that theory with Michelle for 4½ years.  All that yielded was an awkward burger at Chili’s and a quiet ride home.   

There is no one-size-fits-all for portfolio management.  Sell stops may work for some, others use more sophisticated option techniques, technical analysis or they may dial down the risk to less volatile investments.  The commonality is awareness. Dabble around and figure out what works for you.   I tend to go full DOGE on my portfolios during market inflection points.  

Buying an investment is the beginning of a courtship.  We are optimistic and expect a profitable, happy ending.  But I’ve also come to realize things can occasionally get a little sideways and honestly try to evaluate what went wrong.  Was it emotional discipline, poor risk management or just sloppy due diligence?  Like marriage, I’ve accepted it’s a never-ending journey and to avoid chain restaurants.  Happy Saint Valentine’s Day.

1. Courtney Love

2. Coyote Arm

3. Fonzi

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