Wealthcare Investments

Sunk cost Fallacy

In this series of “Behaviour and Investing” I will cover all “thinking errors” that influences our decisions and therefore our financial life.

Second in the series is of 21 is “Sunk cost fallacy”

Sunk cost fallacy is typically described as purchase price drives the decision of discarding it or not. Here, the importance is not given to usefulness of that product or service. In other words, money paid for acquiring a product/service occupies the major space in our mind and deters us to act rationally. 

Let’s take an example – If we look around in our closet, drawers, shelf or loft we will find many items are stacked which we haven’t used for many months or years. Most are outdated, useless and worthless but we don’t do away with them. It could be old piano, old car, non-working gadgets, outdated mobile phones, clothes etc. 

Do you relate with it?

Similar error is also made in Investing!! You Invest in some asset and continue to hold it even if it’s losing money or not making money! Most of the time you continue to hold till the time it doesn’t come to the cost price. We take comfort in feeling that “loss main nahi becha”. By doing this, our mind doesn’t allow us to think beyond and advise us to switch to other asset/product which can be more rewarding.

I have seen Investors holding on to Shares, MF, properties or businesses for 5-10 yrs where the value has eroded by 10% - 90%. That’s really bad financial decision. It’s like betting on last ranked horse with the hope that someday it will come first. Instead why not leave that horse and bet on the horse which is consistently in top quartile.

You made and error at first- that’s fine. Just get rid of it and move on! Look for alternatives. Think that you have gained priceless learning from this bad investing decision.

People tend to be emotional about their own decision and money that leads to sunk cost fallacy.

How to decide rationally?

-         Detach your cost while deciding to act on that Investment.

-         Assess whether the outlook of that Stock/MF or property is good or not.

-         Explore if there is better alternative to Invest.

-         Think about opportunity loss if you still hold on.

-         Seek help of an Investment adviser.

We at Wealthcare Investments believe that if some strategy hasn’t worked for 2 - 3 yrs, we revisit our investment rationale against the market reality and conclude on the next step. It’s better to cut your losses and investing time.

We also do the same for our Investments strategy which has worked well, and book profits and look for next idea. Here we convert notional gain into your actual gain.

MF Trivia: Mutual funds are not equity based only. There are funds which are alternate to FDs, Gold and Property as well. What’s more there are funds which have combination of all four also.

This article is written by Bhavesh D Damania, founder of Wealthcare Investments.

You can reach him at 9833778887 and wealthcarein@gmail.com

"Risk comes until you know what, where and why you are Investing"