The Endowment Effect – Episode 316

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[00:01] Welcome to the Prosperity Podcast. Welcome to another episode of the Prosperity Podcast. Today, we’re going to be talking about the endowment effect. And this may be something you’ve never heard about, but I guarantee something you can relate to. So Kim, this is going to be interesting. I love that you identified it as an economic term. It’s been so fun for us to help people understand that sometimes finances and financial terms, the terms that go with the word finance, are limiting. And so I love pulling people back to economics. And believe me, don’t be rolling your eyes if you hated economics in high school and college because I know I did. And I don’t even try to use that word. But that’s how

[00:50] strongly I disliked those classes. And yet the big reason people are failing with their finances today is because they don’t understand how basic economic theory applies to their personal finances. It absolutely does. And I think we can look at it and we’ll go the most basic, which is the macro level and the micro level of finances. Oh, now you’re really wanting me to roll my eyes. I know, I know. You’re so right. What I want to do, and I think too often, we as a people get overwhelmed because the news or any information we receive is on a macro level. But the micro level or maybe we’ll call it the family level is what all of us should really be paying attention to. So we’ll call it our family economics instead of this world economics. Does that work for you?

[01:50] Yeah, it does. And it’s really well said. You’re absolutely right. We have a serious disconnect in our brains there. Absolutely. So here is one of the terms that we’re going to talk about. And I found this through research as I was learning more about how people think of money and especially this relates to inheritances. So if anyone out there that’s listening has inherited something or some type of asset, this is the time for you to listen. So here’s the term endowment effect. Are you ready for the definition? Yes. Okay. It says this bias occurs when we overvalue something that we own regardless of its objective market value. Put more simply, people place a greater value on things once they

[02:45] have established ownership. So we see this happen all the time. If a parent passed away and they give a guest house or maybe they happen to have an exotic car, maybe some silver coins, but this happened to someone in your family. So I want to hear about the story. Well, it’s an interesting story and it almost twists what’s out there in media land as to, I think what we could define as a somewhat negative aspect of the endowment effect. So the backstory, if you will, is first of all, somebody gets like what you were suggesting, a car, a condo or whatever, and they don’t have a lot of mental and emotional tie in until they get it. And then they almost get too much mental emotional tie in because it was

[03:44] given to them and they have a skewed perspective of it. And I think the media is talking about that in a negative light. I want to talk about it in a positive light. Let’s do it. So here’s the story. If we just covered the backstory, the story is that a long, long time ago when I was relatively new in the business, I helped my sister and her husband purchase life insurance on their children. Pretty common step. And this is whole life insurance, the boring yet effective kind. And I found out later that my sister’s husband absolutely totally disagreed with it. But basically went along because it was like Tammy’s sister, right? What are you going to do? And I’m the older sister, just so we’re clear on that.

[04:32] Yeah, you know, you get some pull in that, of course. I try not to play that card too often, but whether I did or didn’t at the time, that’s the fact. Okay, so fast forward, I’m thinking probably about 20 years, maybe 18 or 20 years, because I think that on their older son, they bought this life insurance when he was around five. And they’ve been putting money in it all along. And they, the parents, had even borrowed against the policy to help the son with some things that were needed as he inched into college. And then it came time to, at their choice, okay, not a legal requirement, but at their choice to give this policy to their son. So this is my nephew. He’s now early 20s. He now owns this life insurance policy and he is paying into it. And remember, he had already

[05:31] benefited from it, but it really wasn’t his. He didn’t have that endowment effect yet in a positive or a negative way. I guess you know what, you could say he did. He had it in a negative way, right? He got it. And he was like, yeah, okay, whatever. I’ll just pay for this thing because my mom says that I have to. Well, about a very short time, six, eight months later, he had an opportunity to borrow against it for himself. And he also, because of that opportunity, dug in and looked at the papers a little bit more and learned a little bit more about this whole life insurance policy that is now, call it 18 years old. It’s 50 bucks a month and he’s in his early 20s with a full-time job. So we’re not talking a lot

[06:13] of money. And yet that policy served him so well that he made a complete 180 in his thinking about it, in his habits around it, because now he’s wanted to pay the loan back faster. And in his appreciation for it, and even better, his dad said to me, now is when I learn I never liked the thing, but oh my gosh, has it served our family well. Wow. You know, that is so strange that it really took 20 years for them to get it. Why is that? Because human nature, especially today in the year of 2019, when we’re recording this, and especially the part of our community that is in their 50s, which is the dad’s age, our age, et cetera, has a misunderstood, completely wrong, to be blunt, knowledge of whole life insurance.

[07:20] For whatever reason, when the 70s and the 80s came about and you had EF Hutton and you had the whole stock market and you had the 401k thing and you have the certified financial planner thing, all of those things conspired to cause our society to literally hate this product for absolutely no reason. But the fact is people do, and they misunderstand it and they don’t want to learn about it because they just parrot the information that they’ve heard typically through media or potentially through other advisors. And it causes them to shut down mentally when they could be learning about an amazing product that enables perpetual wealth. Absolutely. So I think from one of the principles, and I always love when I hear a story,

[08:11] I want to pull a principle, something I can learn and apply. And I’m going to apply what I’m hearing from this and I would love for you to jump in as well. What I’m getting is that to be fortunate enough for them to have seen this opportunity 20 years ago, one, they didn’t frame it as an investment. Is that correct? Absolutely. It is a place to store cash. Now I have mistakenly framed it as an investment myself. And so it’s very possible that I was doing that when they bought it. But I am crystal clear now that it should not be called an investment, is just a place to store cash. Okay. So I think for anyone listening now, if they don’t have a policy and they haven’t done this, when you frame it as a place to store cash, not as an investment, it changes your

[09:03] expectations. Two, I think if you have had parents that set this up or a spouse or someone in the family that set this up for you, maybe you don’t have the appreciation. And so what is the principal knowledge that you could share to the people that maybe aren’t, they’re just kind of taking it for granted. They don’t fully understand the value in this. What is something that you could create a tipping point in their life? What could you say? Absolutely. Yeah. It’s I think the word save and how important it is to have it as a noun, savings as in like cash, emergency slash opportunity fund, extra emphasis on that latter word because nobody wants to be overly focused on saving for emergencies. And then also the verb save or to save, if you will, because we know that saving,

[09:59] that act of saving saves families. And we also know that people like Robert Kiyosaki states that savers are losers. So what is he talking about there when I’m saying save as a noun and a verb is good? And what Robert’s talking about is the unfortunate aspect of cash in a bank, which is impacted by taxes and inflation and potentially the fact that banks only reserve seven to 10 cents on the dollar. What you and I are talking about is saving at again, both as a verb and a noun at a life insurance company, which those dollars are not impacted by taxes. And while they are still impacted by inflation, because the growth of cash value is slightly higher than the growth of cash at a bank. And it pretty much always

[10:54] has and probably always will be the impact of inflation is less. And then of course, mutual life insurance companies do reserve their dollars, dollar for dollar. Most people don’t know that, but that is a critical third piece. And so this whole environment is just so much more efficient. And I get Robert’s point, like it’s a fun soundbite. But the fact is, further savers as a verb, who save as a verb and store money, save as a noun, are winners with a capital W. Because we all know that it’s cash in the bank that creates peace of mind. It creates opportunity. In fact, Nelson Nash has a great saying, which says, if you’re in a position of cash, opportunity will seek you out. Now, how is that being a

[11:46] absolutely agree with that? It does totally seek you out. And I think maybe this is the call to action for this episode. And I always like having the next step. And so I think for any of our listeners, if you have a policy that someone set up for you, and you’re not quite sure how it works. So maybe you were fortunate enough to have a grandparent or a parent or someone and you’re listening to this episode to understand this world. Right now is the time better than ever to reach out and get your questions answered. And you can do that through email. Hello at partnersforprosperity.com. But you can also just learn through some of the things you’ve written. So on the website, partnersforprosperity.com, you have a ton of

[12:36] books. In fact, you got a new book that you just wrote about. We do. It’s called Perpetual Wealth. And I’m so grateful for it because it really puts 30 some years of helping families with their finances into a written tool that families can use not only to make their material monetary wealth perpetual, but also their spiritual and their inspirational and their mental knowledge and that aspect of wealth perpetual. In other words, to pass on a legacy of more than just money, but also knowledge and wisdom and things that are important, like values to the next generation. You know, we didn’t start out this way, but when you now mention the additional topics inside of the book, you’re mentioning what this endowment effect is, because you’re passing on something that has greater meaning

[13:41] within the family. And a sports car or something might not mean a lot to someone else, but within that family, maybe it does. And these values and principles mean so much to that family. So actually, it’s come together. It’s holistic how this episode’s worked out. So thank you, Kim. You’re welcome. Thank you. What a great idea to bring forth. Excellent. And listeners, thank you for spending time with us today on the podcast. If you’re new, make sure you hit that subscribe button so that you can get these episodes every single week. And we have hundreds of episodes that you can backlog and listen to it anytime. So thank you for spending time with us on the podcast. Thank you for listening to the Prosperity Podcast. To take control of your money

[14:28] and have it work for you, visit us at partnersforprosperity.com. If you liked this episode, make sure you subscribe and leave a review.