Behavioral Finance, Investing

The Endowment Effect And Decision Making

In my previous post, I argued in length against stock picking and market timing. Passive investing is the most optimal strategy for most of us retail investors.

I have a confession to make: I am still holding an individual stock in my portfolio – AAPL

AAPL price was currently trading at $325.21 at closing.

Is it overpriced? Yes, in my opinion.

There can be many reasons why the stock price is surging – share buybacks, increase revenue streams from subscription and services etc etc.. but evaluating the share price is not the point of this article.

Will I sell it at this price? No! It is worth more. I will wait to sell it at a higher price.

Endowment Effect

Endowment Effect is when we value something that we own much higher then what we are willing to pay for if we hadn’t owned it.

So back to my case, because I currently own shares of AAPL, I value it more and will not part it at the current market price. Who knows it might go up to $400?

However, if I do not own any AAPL shares, would I pay the current price to own it? No! It is overpriced. Instead, I will look for another more undervalued stock.

This is irrational because the underlying value of the company is still the same and my valuation of the company’s share price should not be affected by whether I currently own its shares or not.

A Good Outcome Does Not Mean A Good Decision

When I first started investing in the US market, my first two securities I bought were AAPL and IYW which is the iShares US Technology ETF.

It was a portfolio containing only the biggest US tech stocks.

Since then, I had became wiser and sold off most of it except of a portion of AAPL for a more reasonable diversified portfolio.

If I had not sold off in 2019, the portfolio would have given me phenomenal gains – all US tech stocks had unbelievable growths at the end of 2019.

If I made the decision to stay concentrated, my gains would be much higher.

Did I make the right decision?

Remember, a good outcome does not justify a bad decision. It might just mean you were lucky.

Decision Making Process is More Important than Outcomes

Good decisions require us weighting all the other option, making tradeoffs and choosing one which will best help you reach your goal.

I made the decision to swap my holdings because the portfolio does not match my risk appetite and my long term goals.

Don’t get me wrong, 2019 had been a good year for my diversified portfolio.

On hindsight, it is always easy to look back and try justify our decisions with the outcome.

If only I had bought Bitcoin before 2018, I would have been rich.

Remember, the inverse is true too: A bad outcome does not mean you made a bad decision.

To Sell Or Not To Sell

So back to the main topic.

Based on my earlier decision, I should have sold it all off, lock in the profits and reivnest into index ETFs.

Then again, my heart says: wait a bit more, just a bit more…

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