The IKEA Effect on Financial Decision Making


Staff member
May 18, 2022
The IKEA Effect on Financial Decision Making

The IKEA effect, coined in 2011, is a cognitive bias that describes how people place a higher value on products that they have built themselves, such as assembling IKEA furniture. This bias has been documented for a variety of consumer goods. While building one's own product increases his or her feeling of competence, it could also lead to an overconfidence bias. Many studies have been conducted to document the prevalence of the IKEA effect when it comes to financial decision-making as well, in particular when it comes to building an investment portfolio individually without the assistance of professionals.

Although an increasing number of individual investors are building their own financial portfolios thanks to social media and zero-commission trading platforms such as Robinhood, this has no direct impact on the overall performance and functionality of financial markets. In many scenarios, it has been witnessed that investors panic-sell during a market crash regardless of whether their portfolios were built with the assistance of a financial advisor or not. However, with changing investor demographics, asset management, financial services companies, and retail brokerage firms may find it necessary to provide further guidance to their self-directed clients to ensure smooth navigation of difficult market conditions.

In the last two years, a new generation of young, first-time investors has emerged who prefer to invest on their own. Lack of investment knowledge is no longer a problem or a barrier to entry into the investment or trading world. The reason behind the rise of young self-directed investors could be fees and commissions associated with all brokerage platforms, which investors may not always be able to afford. Further, studies show that many young investors believe that advisors do not provide enough value for the fees they charge. Many people first became interested in the stock market through virtual stock market game apps that provide users with fake cash and real stock prices, giving investors confidence, and then Robinhood entered the picture, introducing zero-commission trades. Young investors also depend on social media platforms such as TikTok, YouTube, and Reddit for investment advice as they consider these platforms reliable and cost-effective sources of investing knowledge and information. Although the information on these forums is likely to be biased, young investors seem to enjoy the idea of finding a community of people who share similar interests. This shows that if not psychological ownership, the social bias appears to be strong which could significantly impact financial markets in the future.
Self-building a portfolio does not seem to affect one's perceptions of expected return and risk and there is no direct relationship between psychological ownership and the expected returns of an investment portfolio. The ability to self-build, however, may have a substantial impact on financial markets, with an increasing number of new groups of financial investors with greater risk-taking capacity engaging and promoting collaborative investing. This is exactly what happened in the meme stock saga early last year when do-it-yourself investors got together on social media platforms such as Reddit to get behind a few stocks.

Overconfidence bias, however, appears to be driving the new generation of investors, as seen in the crypto market. Although investors are considerably more attached to their self-built products, there is no conclusive evidence to suggest the existence of the IKEA effect for self-built financial portfolios in the current market. It is a significant driver of psychological ownership, but a financial portfolio is intangible, which makes it difficult for investors to show their competence to others, and as it is traded, it cannot be owned forever. This implies that the self-building process has no bearing on trading decisions or the financial market although it could have an impact on financial markets in other ways.