Have you ever gone for a movie, only to realize within 15 minutes or so you are watching one of the worst films ever made! But you sat through it anyway? You didn’t want to waste the money, so you slid back in your chair and suffered.🥴
You are renovating your house and have decided on a new shade for the walls. You thought it would look good, but after painting two rooms, you realise it’s not what you had in mind. But you’ve already spent money on the paint, and you’ve already started painting the house. Do you buy a different paint as per your preference, or do you stick with what you’ve got and paint the rest of your house this colour?
Sanjay is investing in two Large Cap funds – Funds A & B since 2015, he has invested 10 lakh in each. He needs some cash at the moment, so he decides to redeem part of his funds. Fund A📉 is currently valued at 9.5 lakhs and Fund B📈 at 15 lakhs.
He doesn’t want to sell Fund A at a loss, so he decides to sell Fund B, since the amount has increased. I’ll sell “A” once it breaks even.
Which fund would you sell? Would you be willing to sell Fund A and book a loss of 50K?
We all have a healthy aversion to losing money. It keeps us from doing dumb things, and helps us to save for a rainy day. But the sunk cost effect is different. It happens when we fixate on the price we paid for an investment, especially when its value has decreased.
As a result of the sunk cost effect, we stubbornly (and irrationally) hang on to a losing position, hoping that it will eventually return to the price we paid for it. As a wise man said, “You can’t change the past, but you can make adjustments in your present for a better future!”
Let’s apply this insight to investing as well: Don’t make the mistake of selling your winning bets too early and holding onto to our losers too long.
