Inertial Effects - Why Investors Hold On Too Long
People are sticky. Not physically. Mentally. We stick to whatever we already have, whatever is already happening, whatever is the default. And this stickiness costs investors real money every single day.
Chapter 11 of Burton and Shah’s book is about inertial effects. Three related biases that all boil down to the same thing: humans hate change, even when change is clearly better. The endowment effect, the status quo bias, and the disposition effect. Let me walk you through each one.
The Endowment Effect: Why Your Stuff Feels Special
Richard Thaler tells a story about a wine-loving economist. This guy bought some fancy Bordeaux bottles years ago for $10 each. Now those same bottles sell at auction for $200. The economist drinks one bottle per year and loves it.
A student asks: why not buy more at auction? The professor says $200 is too expensive. The student then asks: can I buy one from you for $200? The professor says no way, they are too valuable to him.
Stop and think about this. He will not buy at $200 because it is too expensive. But he also will not sell at $200 because it is not enough. That makes zero sense in traditional economics. You should have one price in your head where you would sell above it and buy below it. But the professor has a gap. A big gap.
This is the endowment effect. Once you own something, you value it more than if you did not own it.
Kahneman, Knetsch, and Thaler tested this with coffee mugs. They gave mugs to half the people in a room (the sellers) and nothing to the other half (the buyers). Then they asked everyone: what is the mug worth to you?
The sellers wanted about $7.12 to give up their mugs. The buyers would pay about $2.87. Same mug. Same room. The only difference was who held the mug at that moment.
They added a third group called “choosers” who could pick between getting a mug or getting money. These people valued the mug at $3.12, almost the same as the buyers. So it was not that the mug was secretly worth $7. It was that owning the mug made sellers feel like giving it up was a loss. And losses hurt roughly twice as much as equivalent gains feel good. That is prospect theory doing its thing.
Here is the thing. Brain scans during these experiments showed that selling something you own activates the same brain areas as pain and disgust. Literally. Your brain treats giving up your stuff like physical pain.
When the Endowment Effect Disappears
But there is an interesting exception. Vernon Smith ran experiments with tokens that had no use outside the experiment. Each person got tokens with different redemption values. A token worth $1 to you might be worth $3 to me. People traded freely, and the tokens ended up exactly where economic theory predicted: in the hands of people who valued them most.
Why did the endowment effect vanish? Because nobody cared about the tokens themselves. The tokens were just placeholders for money. Same thing happens when a shop owner sells a lamp. The shop owner does not feel attached to the lamp. It was always just something to sell for cash.
And get this. When experimenters told people to “think like traders” during the mug experiment, the endowment effect mostly disappeared too. Which is ironic, because as we will see in a minute, actual traders on Wall Street are terrible at thinking like traders when their own money is on the line.
Status Quo Bias: The Default Always Wins
Here is a related problem. When you give people a list of options and label one as the “default,” people pick the default way more than they should.
Samuelson and Zeckhauser tested this. They asked people what to do with inherited money. When they described one investment as the current allocation, people chose that option far more often than when the same investment was just one option among many. Simply framing something as “what you already have” made it more attractive.
The real-world example from the book is powerful. Virginia’s state retirement system set up a matching program in 1997. The state would match employee contributions dollar for dollar. If your tax rate was 30% and you put in $10, the state added $10. Your cost was $7, but $20 went into your retirement. That is a fantastic deal.
But less than 20% of new employees signed up. Because the default was “not enrolled.” You had to actively choose to join.
So the state flipped the default. Now new employees were automatically enrolled at maximum match. Want to opt out? You could. But you had to take action to leave.
Result: 91% of employees stayed in. The program was exactly the same. The options were exactly the same. The only thing that changed was which option required you to do nothing. And that changed everything.
Why does this happen? Prospect theory again. The default feels like your reference point. Moving away from it means risking a loss. And even if there is also a possible gain, losses weigh heavier. So you stay put.
There is also a regret angle. If you actively choose something and it goes badly, that is your fault. If you just stick with the default and it goes badly, well, you did not really choose. It was just what happened. People prefer the version of the story where it is not their fault.
This is why Thaler and Sunstein wrote “Nudge.” Their argument: governments can steer people toward better choices just by picking smarter defaults. You still have freedom to opt out. But most people will not. And if the default is a good option, everyone wins.
The Disposition Effect: Selling Winners, Keeping Losers
Now the big one for investors. The disposition effect is the tendency to sell stocks that have gone up and hold stocks that have gone down. Even when the losing stock has worse prospects.
The book gives a clean example. You own two stocks, both bought at $10,000.
Stock 1 is down $2,000. Going forward, it has a 50/50 shot of going down another $1,000 or going up $2,500.
Stock 2 is up $2,000. Going forward, it has a 40% chance of going down $1,000 and a 60% chance of going up $2,500.
You need cash and have to sell one. Which do you pick?
Rationally, you keep Stock 2. It has better future prospects. The past gains and losses are done. They should not matter. But most people sell Stock 2 and keep Stock 1. They lock in the win and hope the loser comes back.
Why? Mental accounting. In your head, each stock is like a separate bank account. Closing an account at a loss feels terrible. Closing it at a gain feels great. So you close the winner and keep the loser open, hoping the balance will eventually turn positive.
This is prospect theory applied to investing. The pain of locking in a real loss is so strong that people will hold a bad stock with worse prospects just to avoid that feeling. Even when selling the loser would actually save them money on taxes.
And here is where it gets wild. Data shows investors sell winners more than losers in every month of the year except December. In December, tax season is on everyone’s mind. That saliency temporarily overrides the emotional pull. But January through November? Emotions win.
Why This Matters
These three effects are all flavors of the same problem. We cling to what we have. We stick with whatever is already happening. We avoid actions that feel like losses, even when those actions would make us better off.
For investors, inertia is one of the most expensive habits you can have. Holding a losing stock because selling feels bad. Staying in a bad fund because it is the default in your 401(k). Refusing to rebalance your portfolio because you feel attached to the stocks you already own.
The fix is not complicated in theory: recognize that owning something does not make it more valuable. Your purchase price is history. The only question is whether this stock, this fund, this allocation is the best use of your money right now.
In practice, that is extremely hard. Because your brain is literally wired to feel pain when you let go. Knowing about the bias does not make it disappear. But it gives you a fighting chance.
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