Beware the sunk cost fallacy in a post-pandemic world
As we emerge out of lockdown into a post-pandemic world, Kevin Philips considers what this means for the economical future of business and industry.
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Economics has got a lot more exciting than in my heyday if "Economists agree that avoiding the suck cost fallacy is the rational approach to take"!
BTW the fallacy component is based on "At any moment in time, the best thing to do depends only on current alternatives; the only things that matter are the future consequences; past mistakes are irrelevant" ... with particular emphasis on that final phrase.
People that take on board the dictum have been known to 'throw the baby out with the bath water' (i.e. treating everything from the past as irrelevant - whereas plenty of the past will still be highly relevant to the present and the future).
The trick is to have a clear mind and not be blinkered by whatever management fad comes along.
"An example of this approach is the stock market. Do you stick it out with an under-performing share in order to hopefully recoup your losses? Or do you write-off your losses on that specific share and redeploy your funds on better performing opportunities where you can not only recover your initial losses, but also see additional future growth"
Conversely chasing the new bauble may blind you to what you have, you observe your loss and consider the grass is greener, but this has an inbuilt assumption that you now know where the greener grass grows, why should you have that ability now if your past pick was a mistake (and it may or may not have been), why back your skills that have previously failed to now choose a different allocation of your resources?
What you ought to do is forget your entry price and place a value on your investment given the new environment you observe that will impact it, in effect redo the calculations you would have done were you standing with cash on the hip uninvested deciding whether to invest.
Markets over react on both the upside and the downside, given analysis of stockmarket price movements suggest most of the annual gain on a share is made on very few trading days in the year, flitting from one thing to another can be a recipe for losing money.
LTBH performance , if you buy quality in the first place, is hard to beat.
But DJKL has pointed out that your point above is obviously wrong (before I read his comment I was going to make the exact same point as him), since it implies you can correctly predict the future movement of share prices based purely on their past performance.
But to employ the very little Latin I still remember, one also requires to festina lente.
The most difficult skill to master ,imho, is doing nothing, forcing yourself to sit on your hands, give markets time to sort themselves, despite perfect market theories these may only operate over the longer term not the shorter term.
When younger I was as guilty as the next person in seeking instant gratification, it is underperforming, x could do better (omitting x could actually do worse), I learned over time by experience and from my father that reacting is often the worst thing one can do. (this rule also applies to meetings, dealing with one's kids etc, deliberation, measured, ponderous actions often tend to work to one's advantage)
Excellent article.
It made me think of blockbuster and netflix. We all know the outcome and I have often wondered what I would have done if I was Blockbuster's CEO. I could big myself up and say "well of course I would have put money into a streaming service" but would I? Hummm. They had 9000 stores. Would you have stood up to your board and shareholders and investors and said "Yeah, I know. Anyway I'm done with that, gonna close it all down and just going to be a web service".