In 1956, construction began on a supersonic aircraft carrier that would become legendary decades later. But this aircraft wasn’t famous for reasons you may suspect. The project, named Concorde, achieved celebrity status for how expensive it was to build. As construction got underway, it became increasingly more apparent that the airline could never make enough money to recuperate the costs that had been invested in bringing it into existence. The governments and manufacturers involved in the construction had to make a decision: scrap the project, or continue on and follow through with it?
Infamously, those on the committee for the Concorde decided to continue its construction, even when they knew they would never make up the cost. And, what was their reasoning? “We’ve invested so much into the project already–we might as well finish it.” This justification for the failed Concorde project has come to be known as the archetypal example for what economists and behavior psychologists now call “the sunk cost fallacy.”
It’s a peculiar quirk of human psychology that we will continue to invest in something that no longer has value simply because we feel like we will have wasted all of our time, money, or energy if we stop. On the surface, this makes sense to us. But, when we really think about it, we’ll realize that we’re trying to make up for what we’ve wasted by wasting even more! If you’re a sports fan, and you buy season tickets to watch your favorite player and then the player leaves to play for another team, does it make sense to continue to go to the games (when you could be doing something else with your time) if the only reason you bought the tickets was to see the player play?
Economists like to say, “sunk costs are sunk.” What they mean is that once we’ve lost out on a failed investment, we should write it off and not let it influence our future decision making. Watching a favorite sports team we don’t like is a waste of time, no matter how much we’ve spent on tickets. Investing more money in the construction of an aircraft that will never see any return is a waste of money, regardless of how much we’ve invested so far in its construction.
The first suggestion we have when you’re in the scenario as this rut is to stop digging. As investors, we should be mindful of the sunk cost fallacy more than anyone else. Many investors will make a poor investment but refuse to change until it turns around and they see a return. I think this is the sunk cost effect at work. We feel like we’ve invested so much into the portfolio that we can’t stop, or else we will have wasted all of our money. But the fact of the matter is that, if we continue, we are only wasting even more money. It’s never too late to stop making poor decisions. There is always the time to make prudent investment decisions.
Take a look at your current investments. Are you engaging in any behavior that is being influenced by the sunk cost fallacy? Are you throwing away money just because you feel like you’ve burnt a bridge and there’s no turning back? If you feel like you need help grasping which investments are wise and which aren’t, feel free to reach out to us for a free consultation. We want to help you overcome those psychological quirks that trip us all up at times. We want to help you invest your money the smart way