The Sunk Cost Fallacy – Passive Income MD

None of us can be the fictional homo economicus who only makes rational decisions. Instead, we must fight the sunk cost fallacy. Here’s what you need to know about it.

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On the path to becoming financially literate, one of the most important lessons to learn is that personal finances are both personal And Financial “finance stuff” i.e. math is relatively easy to learn. However, it must be aligned with your own values, temperament and behavior. People don’t collect 20% credit card debt because they can’t do the math. That’s why just paying off their credit card for them doesn’t solve the problem. Without changing behavior, they will create debt again.

Most of our financial misbehavior is due to wrong thinking. None of us will ever be speculative, like Spock, though Homo economicus, investors should be aware of some major behavioral finance pitfalls. Perhaps chief among these is the sunk cost fallacy.

What is the sunk cost fallacy?

The sunk cost fallacy is the idea that money you’ve already spent will influence future behavior. This shows up in a bewildering array of financial situations. However, what all these scenarios have in common is that the costs are already “sunk”. They are already gone. They should have no influence on future behavior. “The water is already under the bridge,” “the horse is already out of the barn,” and “the milk is already spilled.” Let go of those sunk costs.

Sunk cost fallacy example

I bet you can relate to one or more of the following examples of how the sunk cost fallacy affects our thinking, our finances, and our lives.

Waiting to be broken before sale

One of the most common ways in which the sunk cost fallacy is the investor’s reluctance to take losses. Imagine you bought a stock at $35 per share. It later dropped to $25 per share. You don’t want to buy it. You wouldn’t buy it now at $25 a share. You will no longer think it is a good investment. But you hold onto it because you don’t want to take the loss. You don’t want to admit you’re wrong. You want to at least get your money out of it. The worst part of this situation is that, at least in a taxable account, you have to take the loss—even if you want to keep the investment—so you can Tax-loss crops.

It shows a lot with it Whole life insurance, too “But if I keep the policy for another seven years, I’ll break it.” No, your damage is already gone. It was used to pay commissions shake The agent who sold it to you. Let it go.

same thing with Annually and other insurance products with surrender charges. In practice, a surrender charge is closely related to commission. Agent/company will get commission no matter what you do. It has already been spent. If you surrender the product now, they get commission as surrender charge. If you wait until the surrender charge is gone, they get a piece of commission every time you pay the life insurance policy premium or the annuity is deducted from the annuity.

This happens with rental properties and even houses. Somehow, we tie ourselves to the price we paid for it, as if it should be relevant to any future decisions we make. It’s true that sometimes due to excess leverage, you literally can’t sell anything because you can’t bring enough cash to the table to pay off the lender. But the price you pay for something doesn’t affect your decision to sell it later. That’s a sunk cost.