Overcome This Investing Trap to Start the New Year

Richard Thaler loved to show just how delusional people can be by using coffee mugs...

Thaler, a Nobel Prize winner, would offer to sell folks a generic coffee mug with a university logo on it. The average price people would be willing to pay was $2.50.

However, if he gave the mugs out for free and then tried to buy them back from people, they'd demand an average of $5.25 for the mugs.

It makes no sense. If folks were willing to buy them for $2.50, then they should be happy to sell them for $2.50, especially considering they were free.

This experiment proves that humans are prone to an emotional bias called the "endowment effect." This phenomenon, also known as divestiture aversion, occurs when we place a higher value on something simply because we own it.

In Thaler's experiment, once the mug becomes "your" mug, it becomes a lot more valuable to you. We demand unreasonably high prices to give away the things we own.

Investors do this all the time...

Think of it this way... Let's say you own shares of retail chain Kohl's (KSS) because you used to work there and received shares as a part of your annual bonus.

But your current portfolio consists of a mix of stocks that have enduring brands and substantial growth potential.

Kohl's fits neither of those requirements. Take one trip to your local mall and you'll see a ghost town. Kohl's used to be a powerhouse brand. But it hasn't kept up with e-commerce and has mostly been forgotten about when folks look for new clothes.

Sales for Kohl's have fallen from $20.2 billion in fiscal 2019 to $17.5 billion over the past 12 months. And it's unlikely things will turn around for the company.

But there are folks out there holding too much Kohl's stock because they value it more than a reasonable buyer would.

They've created a strange link between their identities and that stock.

One explanation is that the endowment effect increases your bargaining power when trading in small groups, giving you an evolutionary advantage. Therefore, we've all descended from ancestors with an endowment effect built into their brains.

Whatever the reason, it doesn't help us today. We've all got a drawer full of junk just like that coffee mug worth, at most, $2.50.

Since we are now in 2024, my advice is to purge the mugs from your portfolio.

A simple test can help you shake off the endowment effect: From our example above, let's say you own $5,000 of Kohl's stock. What if overnight that $5,000 in stock turned into $5,000 cash? Now you have the cash sitting in your brokerage account and no longer own any shares.

You have the choice to either repurchase shares of KSS for the exact same price or use that $5,000 to invest in another stock.

Most everyone would choose to invest that $5,000 elsewhere. Let's face it, the S&P 500 Index includes probably 490 stocks you'd rather own than Kohl's – even though when you owned the shares of KSS, you didn't want to sell and buy something else.

Nothing happened to Kohl's overnight... The only thing that changed is your possessions.

We're in a new year, and now is the time to sit down and evaluate your portfolio. And for anything you own for that matter, think about this...

Mentally clear out your portfolio. Imagine selling everything and going to cash. Then review every investment as if you were deciding to buy it again.

That's the way the market works, really. Everything you hold today, you essentially decide to "buy" anew each and every day. You'll do better to think that way as well.

If you had cash for your current stocks or possessions, would you use the cash to rebuy them or use it toward something else?

If you want to know steps you can take to set your cash up to grow in 2024, watch our first emergency briefing of the year. If you missed this morning's free event, you can catch up here.

What We're Reading...

Here's to our health, wealth, and a great retirement,

Dr. David Eifrig and the Health & Wealth Bulletin Research Team
January 3, 2024