How Failing to Recognize Sunk Costs Keeps Us Stuck in Bad Investments

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A few weeks ago, I had tickets to an NFL game. It was freezing that day, and all my friends backed out. But I didn't want to waste the $70 I'd spent on the ticket. So I went to the game -- and was absolutely miserable. I hate to admit it, but my friends were right.

I didn't even have much vested interest in the teams playing. Nor did I have a good time at the game; I would've been much better off just watching it from the comfort of my couch. But I was obsessed with not having wasted the money I spent on the ticket. In hindsight, I know I should have recognized that it was a sunk cost, chalked up the loss and moved on. I shouldn't have let it cloud my judgment.

But when it comes to to sunk costs, our instinctive opposition to "wasting money" we've already lost can hurt us in many ways. In investing specifically, it can make you hold on longer than you should, and cost you even more.

Wait: What Is a Sunk Cost?

A sunk cost -- money that we've already spent, and that we can't get back -- biases our future behavior. It weighs on our minds and keeps us from making rational decisions. Sunk costs keep us in investments that we otherwise would've abandoned long ago. We use sunk costs to justify our past choices, but they can keep us from moving forward.

And whether we realize it or not, sunk costs are everywhere. If we look hard enough, we can see them in a lot of our decision-making. I can't even begin to count the number of stocks I've bought that have lost money. I've been stuck with the choice of either selling for a loss or trying to buy more to lower my cost basis -- which can be throwing good money after bad.

But the money that you've spent on a stock purchase shouldn't factor in your next decision. You should know what conditions would lead you to sell a stock before you buy it. What if the reason you thought it was going up doesn't pan out? What if the company has a bad quarter? Or the company's management decides to go in a different direction than you expected? Before you even buy a single share of stock, you need to have an exit plan.

You have to sell your stocks -- or hold them -- based on rational criteria. The amount of money you spent when you bought them should not be a factor. That money is gone. It's a sunk cost. Ignore it, and consider only whether an investment is a good or bad deal looking ahead when you make the next decision about what to do with it.

Time Shares: A Classic 'Sunk Cost' Conundrum

Have you ever bought a time share? If so, you're not alone -- millions Americans own them. The problem is that they're typically poor investments that lock buyers into long-term agreements to visit the same vacation destinations each year. They're incredibly illiquid, and they're expensive.

Time shares also come with hefty maintenance fees that you have to pay every year, even if you don't use your annual points toward a vacation. Many people dream of getting rid of their time shares, but they can't -- or think they can't, because of their sunk costs.

So why do we continue to hold onto these poor investments? It's because we've already spent so much money on them; we dread losing the "benefit" from it -- even when it's not such a benefit at all.

Under Water and Treading Water

Despite the fact that the money I've put into my house is a sunk cost, I refuse to sell my home. It's irrational, I know, but I just don't want to lose on the investment -- and if I were to sell today, I'd be out over $25,000 because I'm upside down on my mortgage.

Instead, I'm an accidental landlord -- scared into inaction by the idea of realizing the loss on my big real estate investment. I just can't bring myself to accept that the loss has already happened. Of course, the money I've put into that house is a sunk cost, and it shouldn't factor into my decision on whether or not to sell it. If only I could follow my own advice.

Be wiser than me. Don't let sunk costs lock you into bad investments. When it's time to sell, cut your loses and sell. And don't look back.

Hank Coleman is a financial planner and the publisher of the popular personal finance blog, Money Q&A, where he answers readers' tough money questions. Follow him on Twitter @MoneyQandA.

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betty_brock

I don't want Hank's advice.

January 21 2014 at 5:11 PM Report abuse -2 rate up rate down Reply
bdyftns

How many times in the past has I sold stocks because , as the author puts it, they were 'sunk costs.' In other words they went down and I got chicken. Sure enough they came back up and I'd kick myself in the butt. No more. Dividend reinvestment helps me sleep at night even when a stock has lost some value. I've learned my lesson the hard way. If it's solid, hold on unless something is drastically wrong. They always come back and I'm getting more shares in the meantime. Burn this article.

January 21 2014 at 3:14 PM Report abuse +3 rate up rate down Reply
2 replies to bdyftns's comment
jdykbpl45

Burn its writer!

January 21 2014 at 4:27 PM Report abuse -1 rate up rate down Reply
alfredschrader

To bdy: It's not the article or the writer. You have to understand that when you buy stocks, you have no control over the performance or results, if any, created by the firm.
All you will do as an investor is sit and wait. So you can't be critical of any of this because
you are relying on someone else to create your wealth. If this frustrates you it means instead of buying stocks, you should combine your assets and use these funds to start your own corporation like I did in the 1980s. I found that when I was in control, it made lots of money. Since I owned 98.9% of the shares, any time there was a vote, I won. Remember that when you are the chairman of a corporation you have to conduct the annual stockholders meeting, issue quarterly stockholder statements, and pay-out dividend checks if the board votes to declare a dividend. I did very well and so did the
.11% or the eleven other shareholders. I have a very good track record and can easily do a multi billion dollar IPO, but I have to think about this first before I start another corporation. Many of my contemporaries have spent time in the cardiac ward.

January 21 2014 at 6:20 PM Report abuse -1 rate up rate down Reply
alfredschrader

Bill Gates just said that by 2035 there almost wont be any poor countries and that the US gives less than 1% of it's GDP in foreign aid, especially not enough funds to Africa. Bill is a great guy and a computer personality, but by his statements I can tell he's given very little to anybody except in the form of pledges or promises, or he would know what really going on.
I gave the people of Africa technology worth 100 billion dollars. They did absolutely nothing with it almost expressing a "we are not interested" aproach to my offer.
So I did some research on Africa. Turns out when it comes to wealth, Africa is number one.
Not a typo, number one. Africa has more gold, more diamonds, more oil, and more ag water and ag more ag land than anywhere on earth (ag land and ag water are what you need to grow food. The African Congo river has more fresh water than any river there is ). Giving them money is a joke - they have trillions in gold, diamonds, oil and farm land.

January 21 2014 at 2:31 PM Report abuse -2 rate up rate down Reply
Valerie

Let's see, now --- this writer frankly admits that he doesn't have much financial common sense. Under water on his home mortgage, foolish spending on sports events, etc.

But, we are supposed to believe that he is a "financial advisor"???? And he is arrogant enough to be dispensing so-called "financial advice" on his blog????

If he is a qualified financial advisor --- then I'm a NASA astronaut. (Which I am not.) LOL

January 21 2014 at 2:11 PM Report abuse +4 rate up rate down Reply
jdykbpl45

Hate hank is back!

January 21 2014 at 1:30 PM Report abuse +1 rate up rate down Reply