Sunk Cost Bias is more common than we imagine. Say if you commute a long way to reach a government office, but learn at the main gate that the department is closed for the day, would you like to still go and check anyway, just because you have come all the way? Similarly, would you invest in a stock, even though it is under-performing, just because you have spent a whole lot of time researching and following the same?
'Sunk Costs' are expenses that have been incurred and cannot be recovered. These can be in terms of money, time, labor, or a combination. A Sunk Cost Bias is experienced when we get emotionally attached to our investments and are unable to let go due to the cost of acquisition associated with the investment. We are often caught between reducing the losses and maximizing the gains and hence it becomes increasingly difficult for us to let go.
Sunk Costs for Investors
An investor who has put money into a particular fund will continue to remain invested, even if the fund is under-performing, for he believes that since he has already invested and spent so much time, exiting now will not be wise. In the hope of a revival, he continues to stay invested, while the corpus continues to erode in the process.
The above example illustrates that investment decisions are primarily affected by the acquisition cost and not by a rational decision-making process. Ideally, the investor in the above example, should not have been influenced by the acquisition cost of the fund and should be willing to make the most of the present. But more often than not, we get emotionally attached to our investments and the more we invest (including time) in something, the harder it gets to let go.
So how do we avoid this?
Admit Your Mistake -
Do not let the 'fear of failing' keep you from admitting your mistakes. Accepting the fact that you faltered will enable you to take preventive measures sooner, thereby cutting your losses.
Move On! -
We all expect a good return for our investments but sometimes our choices backfire and we end up losing money. You might be lured to stay invested but do not let the acquisition cost cloud your decision. Consider the possible corrective actions you can take.
Focus On Achieving Your Goals -
Most people start investing with a goal in mind. If your long-term goal was to create wealth, do not focus on short-term loss. Perhaps it will be wiser to sell now and invest elsewhere. You might still generate the profits you originally planned for.
Live In The Present -
Do not let your past actions influence your present decisions. The money is already gone, but your mind doesn't allow you to sell! In such a situation take stock of your current choices and only consider the future growth projection to decide between a buy or sell option.
Learn more about Sunk Cost Bias with Rolf Dobelli, the author of 'The Art of Thinking Clearly'. Watch this video.
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