Do you have any stocks that light up red when you log in and need to check your positions?
Do you think that now you want to “just hold on”?
And do you think that without having done an analysis of the company? Do you hold on even though you know deep down that you’ve made a mistake?
Then you may be affected by what is called the sunk cost fallacy.
This means that you will not accept that you have been wrong and wasted your money, your time or your energy.
It can happen to anyone. It once happened to Warren Buffett as a young man. He had bet on a slow horse in a horse race and lost.
Instead of going home, he bet more money on another race, which he also lost.
He went on and on until he had no more money. He lost what was equivalent to a grown man’s monthly salary.
Why did he react like that?
Because he had a hard time accepting that he had made a mistake and lost money. He tried to win them back. It is actually an illogical move because each new bet must be seen as an independent decision.
In this article, I will tell you how to avoid it and what to do. But first, we need to understand it a little better…
Friendship and trousers are also affected
The sunk cost fallacy can hit all sorts of places in our lives.
This is also what is at stake when we hold on to a dysfunctional friendship that we have had since college.
It’s at stake when we stay in a relationship that doesn’t bring anything good but has been around for so long that it’s the only reason we’re holding on.
There may be a voice that says, “Well, we’ve known each other for 15 years – 20 years – 30 years.”
It’s time you’ve invested in that relationship. That’s why you keep showing up to birthday parties, couples dinners and still spend your valuable time doing it, even when your old friend doesn’t support your plans or mock you for your decisions.
It’s the same problem that people with many things have.
They hold on to things because they once cost something. Maybe it’s a pair of pants that they can no longer fit. They don’t use them, but they still remember how much they cost and where they bought them. It was USD195 in some fancy shop somewhere in 1998.
Even though they know they’ll probably never wear them again, they keep the pants (or the bag or the machine) because they feel like they’re losing the money the moment they part with it.
But the money is already lost.
The losing case accumulates
It may also be that you have started a business and have invested time, money and resources in it. Every week you have costs to keep the business going. Plus all the time you spent on it.
The years go by, the costs accumulate, and you still don’t make money from it. Each week you keep posting more time and more money after that. It becomes a bigger and bigger loser.
Why not just close the project and focus on something that you can make money from?
Because you have invested and REFUSE to give up and thus wave goodbye to all the expenses, hours, and resources.
It may also be that you have invested in a share which has fallen. Maybe you think “NOW it must have reached the bottom,” and then you might buy even more shares.
People are more likely to sell stocks on which they have made a profit than to sell stocks on which they have lost money – even if the losing stock investment is a completely hopeless business and the good investment has a bright future.
It’s illogical, but that’s how people do it.
Here’s how to avoid it
Warren Buffett learned an important lesson from burning through a lot of money on the racetrack. He promised himself he would never react the same way again, and it has made him a better investor.
As Warren Buffett says: “You don’t have to make it back the way you lost it:”
He is good at pulling himself out of positions that he no longer believes in.
How do you avoid falling into the sunk cost fallacy trap?
- Take as a starting point how the situation is right now.
- Accept that the past is the past. It doesn’t matter what happened before.
- Look at the future. Assess whether the investment will give a good return in the future.
You should approach all areas of your life with polished glasses. You should look at it as if the past did not exist and have the courage to make changes.
Would you make that investment now – with the knowledge you have today?
When you hold on to things solely because they have cost you something, you are undermining your future.
Because one thing is certain.
It is not with one foot in the bad decisions of the past that you break free and achieve such a good return that you become financially independent.