Sunk Cost Bias (Fallacy) is a real and damaging phenomenon that we are often unaware of. It is our tendency to continue investing in something, whether it’s money, effort, or time, even when the costs outweigh the benefits. This behavior is associated with “Commitment Bias,” where we stick to our past decisions despite evidence suggesting it may no longer be the best course of action.

This bias affects various aspects of our lives, including relationships, career decisions, and sticking with something solely because of the investment, rather than cutting our losses and walking away.

I recently read a psychology book that discussed the sunk cost fallacy using an illustration of someone at the movies. After realising the movie is terrible and uninteresting only 10 minutes in, they face the decision to either leave and save time and energy or stay since they’ve already paid for the ticket. Many people choose to stay due to the fear of the sunk cost bias, even though they know it’s a loss either way.

The sunk cost fallacy has led to major blunders, such as the F-35 fighter jet debacle, where the US Army spent two decades and billions of dollars developing an inferior jet. Even though cancelling the project was the most rational and logical solution, the significant investment in the program made pulling the plug hard.

There is an emotional attachment…

The Sunk Cost Bias creates a paralysis in our investment decisions, and this behaviour can be damaging to investment portfolios, causing a decrease in wealth.

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We cannot choose our external circumstances, but we can always choose how we respond to them.

Epictetus

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Successfully investing in the stock market is not an easy feat. It requires a multidisciplinary approach to looking at opportunities and weighing them up with sound and proven fundamentals. Our behaviour lies at the very top, before financial spreadsheets, before price charts, before the nitty-gritty of deep research; we must check our behaviour.

Our mind can be the number one reason that counters all our intellect and investment knowledge. Investing successfully over long periods of time is not all number crunching. Someone can have a tremendous amount of knowledge about markets, investment theory, technical or fundamental analysis, yet when putting the process to work, if the behaviour is not in check, sooner or later, losses, big losses, will follow.

I am yet to meet any successful long-term investor who had all brain yet lacked awareness about themselves and their patterns and was able to succeed over the long haul. Perhaps in shorter bursts, yes, but over long periods of time, it was not sustainable.

Humility and awareness of Biases…

I believe one of the issues that can contribute to a Sunk Cost Bias mindset is due to a lack of humility. For myself, I believe early on, the ego and lack of humility played a key role. I just couldn’t fathom I got something wrong. In my beginner days of investing, before I really understood the massive world around investing and behavioural finance or even having a thesis, I would do some quick searches and take a position (Just like that).

Prices would move against me, and sharp declines in the holdings caused me to go through all different motions in my head. Only after 15 years of understanding the investment game a little more each day was I able to question my irrational behaviour. In my defence, I didn’t even know there were terms like this to explain the way we do things.

Sunk Cost Bias Examples.

Below are a few examples that I have come across or admittedly have performed myself.

Example: When the price of a stock drops and you decide to “Double Down” without reevaluating your initial investment thesis, it may not be a good idea. While buying a discounted stock of a company you believe in can be a good strategy, it’s important to have a clear reason for holding the stock. Instead of blindly trying to average out your position by buying more when the price dips, it’s essential to consider whether your initial investment thesis was incorrect.

Example: Holding onto a position even when the company’s fundamentals have changed and it’s no longer a good investment can be a common mistake. It’s important to accept when an investment thesis is no longer valid and be willing to sell to avoid further losses.

Example: Many investors struggle with the emotion of hope when holding onto an investment that is unlikely to recover. Hoping for a break-even or minimal loss instead of exiting entirely can lead to further losses. It’s important to assess whether it’s time to move on from an investment. Cutting losses is often the best decision.

Example: Understanding the concept of opportunity cost and being aware of alternative investment opportunities is crucial. If an investment is not performing as expected, it’s important to consider reallocating capital to more promising opportunities instead of waiting for a turnaround that may never come. The sunk cost bias can however get in the way of this.

You will have a few losses along the way.

We will never win all the time. You will experience losses in your investing journey, but minimising losses is part of the process. We can achieve this by gaining a better understanding of our behaviour, not chasing after losses, and understanding what we own and why.

Having a thorough independent review of your investments can help you stay rational. If a position decreases in value, you won’t be concerned because you understand what’s in your portfolio. You keep track of its earnings, updates, and evolving information, so you’re less likely to be shaken every time the stock price falls.

We need to use logic in our approach. I’d rather take a small loss and move on to my next idea than hold onto significant losses because I ignored that I was wrong.

How can investors be mindful of the Sunk Cost Bias?

It’s okay to be wrong. Firstly, accepting that we are human and get things wrong will go a long way in evolving our humility around investing. It’s okay to change your mind. If we make a decision based on information and create a thesis to take a position, then that thesis is not set in stone. If new information arises or something changes in the business model and it declines, it’s okay to accept that it was wrong and move on quickly.

Just because you’ve invested in something and it’s declining doesn’t mean it’s worth hanging onto while waiting for a rebound — often it never comes.

I believe this is why we have a thesis and inside the thesis, the risks are outlined around what would trigger you to exit a position. It’s not based on price fluctuations. If the company is still earning and growing, yet the market punishes a stock, it’s not a reason to sell. If the fundamentals of the company such as the business model, new threats, or financial issues have changed, then that may trigger a sell.

It’s harder to implement in practice than it is to read about it. It’s a discipline of understanding what you own and having conviction about owning it.

An example of one of my many blunders…

I write about a behaviour I know something about, let me share my experience with the Sunk Cost Fallacy. I was 20 years old, had little understanding of investing, and no investment strategy. Over 12 months, I fell victim to the sunk cost bias, doubling down, trying to buy the dip, and catching falling stocks, resulting in a significant and permanent loss of capital.

I thought the stock would rebound, but I didn’t do enough independent research. I was influenced by others who believed in a massive rebound, and I didn’t realise the risk of investing without fully understanding what I was investing in. Having made money on the company previously, I assumed it would continue.

I also lacked the experience to know that when a small-cap stock goes down, it can keep falling. There is no bottom until it hits zero. When something dives like this, our minds struggle to accept that it can go bankrupt. At that time, I didn’t fully comprehend the potential consequences of my behaviour.

UNIT PRICE:	BUY/SELL:
$            130.69	BUY
$               59.06	BUY
$               38.66	BUY
$                 6.54	BUY
$                 4.81	BUY
$                 3.31	BUY
$                 2.10	BUY
$                 1.53	BUY
$                 0.99	BUY
$                 0.087	BUY
$                 0.002	BUY

This is an exact chart of my transactions and the price points, I omitted the amount of shares. I sh*t you not, this is what I did.

If you feel like this article nudged you the wrong way and rather than accept that you also have a bias, just look at this chart again of my own blunder. I write from experience, don’t be like younger me, just don’t be that guy.

So, in summary, check your Sunk Cost Bias, be aware of the behavior. When something takes a dip, stop and assess your thesis and think: am I being irrational? Is there good reason to put more precious capital into this?

🚢 Don’t go down with a sinking ship…