Thursday, August 1, 2013

The sunk cost fallacy...

From The Art of Thinking Clearly by Rolf Dobelli:
The sunk cost fallacy is most dangerous when we have invested a lot of time, money, energy, or love in something. This investment becomes a reason to carry on, even if we are dealing with a lost cause. The more we invest, the greater the sunk costs are, and the greater the urge to continue becomes. 
Investors frequently fall victim to the sunk cost fallacy. Often they base their trading decisions on acquisition prices. “I lost so much money with this stock, I can’t sell it now,” they say. This is irrational. The acquisition price should play no role. What counts is the stock’s future performance (and the future performance of alternative investments). Ironically, the more money a share loses, the more investors tend to stick by it. 
This irrational behavior is driven by a need for consistency. After all, consistency signifies credibility. We find contradictions abominable. If we decide to cancel a project halfway through, we create a contradiction: We admit that we once thought differently. Carrying on with a meaningless project delays this painful realization and keeps up appearances. 
“We’ve come this far . . .” “I’ve read so much of this book already . . .” “But I’ve spent two years doing this course . . .” If you recognize any of these thought patterns, it shows that the sunk cost fallacy is at work in a corner of your brain. 
Of course, there may be good reasons to continue investing in something to finalize it. But beware of doing so for the wrong reasons, such as to justify non-recoverable investments. Rational decision making requires you to forget about the costs incurred to date. No matter how much you have already invested, only your assessment of the future costs and benefits counts.