Why we hang on too long

Why do we hang on – too long – to things that are just not worth it!

No, this Insight is not about personal relationships!

Although it might explain some aspects of them 😉

This is about a natural human behaviour that can get us into a lot of trouble – unless we manage it.

The ‘endowment effect’ is the curious behaviour whereby we over value the things we own.

Identified by Nobel Prize winner Daniel Kahneman and colleagues in 1990, this is nothing to do with our ‘keepsakes’ – the odds and ends we hang on to for years because of the memories they inspire. This is about how we tend to over value everything else, including our investments and our home.

So let’s think about homes for a minute.

Any good economist will tell you that house prices tend to be ‘sticky’ on the way down.

And what they mean by that is that prices get ‘stuck’ at a certain level before snapping down to the next level to get stuck again there and so on.

They tend not to fall smoothly in neat percentages.

Oh and Yes, house prices do fall (a lot) sometimes – as we’ll see in a minute.

The point about ‘price stickiness’ is that it’s caused by home sellers ‘holding out’ for prices that are higher than the buyers will pay.

Okay but so what?

Well, the thing about asset markets (in houses or stocks) is that they really don’t care what we think our assets are worth.

Our ‘stuff’ is only worth what we can sell it for.

And when we need to find some cash, it’s no good holding out for a price that no one will pay – especially in a steeply falling market.

That’s just gonna savage your proceeds.

Now I know this idea goes against the old ‘conventional’ wisdom . . . that markets always go up over time.

But the fact is that they don’t.

And it’s really best not to have to experience a full blown collapse in house or other asset prices to understand that.

You can just look at the data . . .

and if you’re not sure where to find it – I’ll provide plenty of pointers to it from here.

So stay tuned – or just grab a copy of my book.

Now, here’s a personal story to bring this to life.

When I moved to work in the city of London in 1990, I wanted to buy a small flat in Docklands.

House prices were much cheaper back then. So I’ve converted these prices into today’s money terms.
Even so, I suspect they’ll still look very cheap to you if you live in London – which I hope warns you how seriously over stretched house prices are today.
We’ll come back to this another time.

Anyway, back to the story . . .

The guy selling the flat that I was looking at  – wanted too much for it.

He was asking £240,000 for it – which was more than similar properties were selling for.

And I was concerned about house prices – which were now falling quite heavily, nationwide.

I thought the flat was worth c. £220,000 at most. So I offered him £200,000 . . . expecting there to be some ‘haggling’

Unfortunately, my offer upset him and he accused me of insulting him with it!

I explained that there was nothing personal about this! It was simply an offer and as he’d refused it – I wished him well in selling his flat to someone else.

I then went on holiday thinking that the deal was over.

Two weeks later the same guy called me to say he’d now like to accept my offer.

I reminded him that as he’d already refused it – it was no longer on the table.

Prices were continuing to fall, so I said I’d get back to him if I was still interested – and then pondered on the question for a few weeks.

I then went back to see if the flat was still for sale – which it was – so I made a fresh offer of £170,000.

Needless to say he got ‘really upset’ this time – and called me all kinds of names before slamming down the phone.

(You could do that – with phones – back in the day)

Then, to my amazement, another two weeks later – he called me back and asked (politely this time) if I’d be prepared to buy his flat for my most recent offer of £170,000 – which I did.

Now, just to be clear, I’m not claiming to be any kind of property buying ‘Guru’ – indeed nothing could be further from the truth.

And as it turned out, house prices kept falling in that crash for another six years – until 1996 by which time my flat was only worth about £130,000!

Prices of modern flats (around the UK) fell by 50% or more in that crash of the early 1990s.

But the message here is simple.

Do what you can to get the best price for the stuff you sell.

But also be prepared to accept a fair price for it.

That’s easy to say but difficult to do eh?

Clearly I should have held out for longer before buying that flat.

But I didn’t have a clue about general market valuations back then.

So we’ll take a look at that  – to see if the housing market remains overheated in a future insight

Hint – it is! 😉

But market distortions aside . . . what’s the conclusion here?

Well its simply this

A fair price for any asset is what other (reasonable) people will pay for it.

And our instinctive views of value are often distorted.

Knowing about this ‘endowment effect’ can help us remember that.

Take care out there.

Paul

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