We all know we shouldn't throw good money after bad, but we do it all the time.
Perhaps you’ve made yourself sit through a bad movie purely because you felt that having paid for the ticket you didn’t want to be left with a sense of money down the drain? Or, for the same reason, you’ve read a whole book despite deciding by the end of Chapter 1 that you weren’t going to enjoy it.
The sunk cost fallacy
Behavioural economists call this tendency among people to stick with losing propositions as the sunk cost fallacy. You see it all the time in consumer finance, investment and business.
Think of the person who buys a motor vehicle that turns out to be a lemon. The buyer constantly is sending the car to the garage to be fixed. Yet every time it comes back from the mechanic something else goes wrong. The consumer would have been writing it off early in the piece.
Investors are affected too
This happens with investments as well. People will get overly attached to losing stocks and refuse to sell them, purely because they feel they have already stuck with them for so long and want to believe that at some point they will turn around.
There are a few ways of overcoming this tendency. One is not to become emotionally attached to investments. A bad movie doesn’t stop being a bad movie just because you doggedly opt to sit through the entire feature. Your money is gone; now you’re wasting your time as well.
A second approach is to look to the future, not the past. Maybe the next movie will be better. A third idea is diversification. Accept that not every movie you see is going to hit the mark. But if you see a range of them, something might take your fancy.
See the big picture
A final way of framing this challenge is to think of the big picture. People tend to place a higher value on what they might lose rather than on what they stand to gain. Walking out on a bad movie opens up the possibility of a better experience doing something else.
Bad movie or bad investment, that money and time wasted is gone. You can’t do anything about it. But you still have options and choices. And that starts with writing off a losing proposition.
The sunk cost fallacy is just one many behavioural biases that investors are prone to. We explored some of the most common biases in our six-part video series Your Own Worst Enemy. The series is well worth watching, and if you have any queries on this subject that we can help you with, please get in touch and we'll be happy to help you. ROBIN POWELL is RockWealth's Head of Client Education. He's also a freelance journalist and edits the highly acclaimed investing and personal finance blog, The Evidence-Based Investor. You can follow him on Twitter @RobinJPowell.
