Sunk Cost Fallacy and Stop Loss
Sunk Cost Fallacy (SCF) is one of the first notions they teach you in Investing 101.
SCF means that no matter how much time, money and mental energy you have invested in a project, there is no reason whatsoever to keep throwing good money after bad, unless you would have chosen to enter the project in its current status.
3 minutes about SCF that are so clear that it’s almost silly
A related notion is the so called “Stop Loss”, where you simply pull the plug on a losing investment, when you no longer believe it will produce a positive return – no matter how much you have lost. “Hoping” for a comeback is no strategy. Actually, I am more of an advocate of “Stop Profit”, i.e., knowing when you have gained enough and it is time to get off the bullet.
Sunk Cost Fallacy and Stop Loss lines of reasoning are applicable to all areas in life. Girlfriend/wife, employer, stock portfolio… If you wouldn’t have entered into the situation from the outside now, then you should get out, no matter the history.
Take a good look at your current situation in a number of respects:
- School – should you stay or drop out. Will you earn more, learn more if you stay or if you quit? Are you studying the wrong major? Switch, even if you’re two years in – or you’ll regret it for 50 years.
- Job – are you satisfied? Are you looking for alternatives? Ask yourself exactly why you are staying. Why would it get better this year?
- Investments – perhaps stop profit is more applicable here. Do you have a well thought out long term plan for your holdings? Are they cheap? If not, are you prepared to hold on no matter how deep the coming correction gets?
- Girlfriend – are you staying out of loyalty and pity? Nobody is a winner in that situation. Do both of you a favor and pull the plug.
- Stuff – car, summer house, watches, boats; whatever stuff you have – are you just holding on or do you have a plan that gives you value going forward?
- Reading a boring book, watching a boring movie – just stop, it won’t get better unless they switched author, director, actors half-way.
Don’t lose face
But, but.. you don’t want to look bad, like a schmuck, that ditched a project that had cost so much. Well, you’ll look even more the fool if you dig yourself even deeper into the hole before being forced to give up.
Or, are you that guy that walks the final two blocks to a store you just realized is closed?