The Lost Money Fallacy
Nov 30th, 2008 Posted in In Claire's World..., Money | 3 comments »The lost money fallacy is often also known as the sunken cost fallacy. When we spend money on something we own, natural human psychology produces the desire for us to keep it or put more money into it when it is most cost efficient to let it go. The bottom line is, no matter how much you paid for something, it is worth whatever it is worth at its present state. The money you put into your investment or purchase that has been lost will not be recovered simply because you’re making desperate attempts to keep the investment or product afloat. The price you originally paid for it should not affect your decision in what to do with it. Take a look at the examples below, and see how you would act if you were in these situations.
Example 1:
In the current economic state with declining securities, such as stocks, housing values, and commodities, we are often hesitant in selling our losing securities. People often irrationally hold onto their losing stocks that are currently trading at less than they paid for, because they don’t want to lose the money they originally invested. This causes them to lose more money on their bad investments as the stocks continue to decline.
Example 2:
You buy a show ticket on impulse thinking you got a good deal, but later you decide that you really don’t want to watch it anymore after you find you don’t have the least bit of interest in what it’s about. Natural human psychology will cause you to spend time watching the show anyway, just because you paid for it. You end up watching the show wasting valuable time and needing to endure watching a show that you would really prefer not to see.
In example 1, if you would not buy the stock at its current market price and state, then you should sell it regardless of how much you paid for it. Holding onto the stock when you don’t think it will be a good investment will only lead to greater losses.
In example 2, it would be most efficient if you didn’t watch a show that you wouldn’t enjoy, because you could spend that time and energy doing something else. The fact that you already paid for the show will not make it any more enjoyable for you. Give the ticket away and find something better to do with your time.
Remember that money already spent and lost should not affect your financial decisions. It’s just gone.
