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Oliver Herren

«Doing it yourself gives you a good feeling. But often a poor performance.»

Oliver Herren

The IKEA effect: pride is a bad investment advisor

12.10.2015
Oliver Herren

How do you feel about your portfolio? Are you proud of your selection? Then watch out. You may be falling prey to the IKEA effect.

We are very proud of many things that we have planned ourselves and made with our own hands. For one person, it's the home-made jam from their own raspberries. For another, it's the lovingly restored secretary from the local bakery. As soon as you have finished, pride speaks. His message is clear: there is no better jam, no better secretary in the world. Because whatever you make with love, it can only be the best.

Surprisingly, however, this feeling of competence arises even if you don't love what you do from the outset. It is enough that you do it at all. The love for the product then comes all by itself. At least that's what US economists Michael I. Norton, Daniel Mochon and Dan Ariely have discovered.

Pride lurks everywhere

In their study, they found in a series of experiments that their test subjects valued the same objects more and would even be prepared to pay more for them if they had assembled them themselves. Even when it comes to an object as banal as the «Kassett» storage box from IKEA. Building it yourself gives a feeling of competence, researchers call it the IKEA effect.

Kassett Box
Much more than a box (at least if you have assembled the «Kassett» box yourself).

Some people love investments. They enjoy insider tips, they like picking shares and they are proud when their investments perform well after they have bought them. For other people, investing is more of a necessary evil. Something they have realized they should do. But for them too, as soon as they buy their first share, fund or ETF, the IKEA effect kicks in. Suddenly, even the dispassionate must-have investors are emotionally attached to their decisions. Doing it yourself makes you feel good. But often a poor performance.

Too proud to make good decisions?

The IKEA effect is immediately problematic if an investment does not perform as desired. After all, hardly any private investors part with the losers. Most prefer to wait until the share has recovered to the cost price. Even if it could often make more sense to realize the initial loss quickly and take advantage of a better investment opportunity with the remaining money. But there is one obstacle to this: the investor would have to admit that he was wrong. And that doesn't fit in with the feeling of competence.

The IKEA effect can also dampen the performance of investments that have performed well. After a long boom, it can often make sense to reduce the position. But the typical private investor feels exactly the opposite. The performance seems to confirm his decision: The investment has made money, he is proud of it, and he will stick with it.

Only discipline can help against pride

If you don't want to be blinded by the IKEA effect when constructing and managing your portfolio, you need two things: firstly, clear goals for each individual investment. Ideally documented in writing, so that you can remember them correctly later if in doubt. And secondly, regular monitoring. So that you can check each investment to see whether it still meets your objectives. To summarize in one sentence: a lot of discipline.

You can apply this discipline yourself. Or you can have it applied: for example, by a professional asset management company. With modern online solutions, this is now available to all investors. With True Wealth, it starts from a minimum investment of just CHF 8'500.

Disclaimer: We have taken great care with the content of this article. Nevertheless, we cannot exclude the possibility of errors. The validity of the content is limited to the time of publication.

About the author

author
Oliver Herren

Oliver is one of the founders of the largest online retailers in Switzerland: Digitec Galaxus AG. He founded True Wealth together with Felix in 2013.

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