We've all been there: you've invested a lot of time, money, or effort into a project, but things aren't going as well as you had hoped. You may be tempted to continue investing in the project, even though it is not likely to be successful, simply because you don't want to "waste" the resources that you have already invested. This is an example of the sunk cost fallacy, a cognitive bias that can lead to irrational decision-making.
What is Sunk Cost fallacy:
The sunk cost fallacy occurs when we make decisions based on the resources that we have already invested in something, rather than on the potential future returns of that investment. This can lead us to continue investing in projects or activities that are not likely to be successful, simply because we don't want to "waste" the time, money, or effort that we have already invested.
Example of sunk cost fallacy:
Mr. Ajay bought 1,000 shares of XYZ Limited for $100 each, but the share price has fallen and the shares are now trading at $60 each. This means that Mr. Ajay has a loss of $40,000 on his investment. Mr. Ajay is presented with the opportunity to invest in shares of ABC Limited, which are trading at attractive valuations. Mr. Ajay has the option to sell his shares in XYZ Limited and use the proceeds to invest $60,000 in ABC Limited. However, Mr. Ajay decides to hold onto his shares of XYZ Limited until he can recover his original investment.
In this situation, Mr. Ajay has fallen into the trap of the sunk cost fallacy because he has passed up the opportunity to invest in ABC Limited, which has the potential to generate profits, in order to try to recover his investment in XYZ Limited. Even though there is no guarantee that Mr. Ajay will be able to recover his original investment in XYZ Limited, he has decided to hold onto it because he has already invested time and money into it. This decision is not based on the fundamental value or potential future returns of XYZ Limited, but rather on the fact that Mr. Ajay has a loss on his investment and is unwilling to accept it.
How to overcome sunk cost fallacy:
In order to overcome sunk cost fallacy, you will have to be aware that you are susceptible to sunk cost fallacy. Being aware and alert is the primary part to avoid the sunk cost fallacy.
Here are a few tips:
Take a step back and objectively assess the situation. Try to look at the companies in your portfolio as if you had no prior investment in them. What are the potential future returns of this investment? Is it likely to be successful, or is it time to cut your losses?
Consider the opportunity cost of continuing to invest in the company. What other opportunities are you giving up by continuing to invest in this company? Could you be investing your time, money, or effort in some other company that is more likely to be successful?
Don't be afraid to walk away. It can be emotionally difficult to accept that the investment has not been successful and that it is time to move on. But sometimes, the best decision is to cut your losses and move on to something else.
By being aware of the sunk cost fallacy and taking steps to overcome it, you can make more rational, well-informed decisions and avoid wasting valuable resources on projects that are not likely to be successful.
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