Disposition Effect

A client inherited shares in a single company from her grandmother and tells her adviser that she would never buy them at the current price, but she will not sell them either. This best illustrates

1. A.the disposition effect.Wrong. That describes selling winners and holding losers, and nothing here turns on gain or loss.
2. B.familiarity bias.Wrong. She is not favouring a category she knows; she is attached to this particular holding because it is hers.
3. C.the illusion of control.Wrong. She claims no ability to influence how the shares perform.
4. D.the endowment effect.Correct. The stated gap between what she would sell for and what she would pay is the signature of the bias.

Why: The endowment effect is the tendency to value something more highly simply because one owns it, which shows up as a gap between the price at which a holder would sell and the price at which the same person would buy. The client has stated that gap explicitly, which is what identifies the bias, and the emotional provenance of the shares deepens it. The practical harm is a concentrated position that survives only because selling feels like a loss of something more than money. The test an adviser uses is exactly the one she has already failed, asking whether she would buy the position today at its current price.

Reviewing the trading history of a taxable account, an adviser sees that the client consistently sells positions showing a gain and holds those showing a loss. Beyond the behavioural error itself, the adviser should point out that the pattern

1. A.accelerates capital gains tax while leaving the available losses entirely unharvested.Correct. The bias moves tax forward and forgoes the offset, which is the reverse of tax-efficient practice.
2. B.reduces portfolio turnover and therefore the total transaction cost of the account.Wrong. The pattern generates a steady stream of sales, so turnover rises rather than falls.
3. C.converts what would have been long-term gains into short-term gains.Wrong. Nothing in the pattern establishes how long any position was held before it was sold.
4. D.is tax-neutral, because gains and losses offset one another over a full market cycle.Wrong. The offset never arrives, since the losses are the very positions he refuses to realise.

Why: The disposition effect has a tax consequence that compounds the investment one. Selling winners realises capital gains and brings the tax forward, while holding losers leaves losses unrealised and therefore unavailable to offset those gains or ordinary income. The result is a portfolio that pays tax earlier than it needs to and never harvests the offset that was sitting in the account the whole time. Deliberate tax-loss harvesting is the mirror image of the pattern, which is what makes the behaviour so expensive: the client is systematically doing the opposite of the tax-efficient thing.