“My father is driving me crazy,” she said.
“On the marriage thing again?” I asked.
“Not really,” she replied.
“Then?”
“He wants me to go through his stock market investments and clean up his portfolio.”
“That means he has confidence in your abilities,” I replied. “You should be happy.”
“That I am.”
“Then what is the problem?”
“Well, he has invested in so many stocks.”
“So?”
“Many of these stocks are now way beyond their heyday. And he continues holding on to them.”
“Have you spoken to him about it?” I asked.
“Yes.”
“And what does he say?”
“Oh. He doesn't want to sell them for a loss. He is waiting for the day when the price will rise, and his investment will be in positive territory again.”
“Ah, the classic sunk cost fallacy.”
“The what fallacy V?” she asked.
“The sunk cost fallacy.”
“And what is that?”
“Once we have sunk money or our reputation into a deal, we would rather make the best of it than go back on it. It also leads to an escalation of commitment.”
“Which is what has happened to my father. He wants to hold on to all these dud stocks, in the hope that one day his investment will be in positive territory once again.”
“Can I have a look at his investments?” I asked.
“Sure,” she said, handing over a few sheets of paper to me.
“Just as I suspected,” I said, after quickly going through the sheets.
“What now?”
“Other than holding on to his bad stocks, your father has also been buying the same set of bad stocks, over the years.”
“Oh, but why would he do that?” she asked.
“Escalation of commitment.”
“As in?”
“Well, from the sheets you gave me, I can infer that every time the stock price fell by more than 5%, your father bought the stocks.”
“What was he trying to do?”
“He was basically trying to drive down his average cost of purchase of these stocks, so that once the stock price started rising, his investment would be in positive territory faster than in comparison to doing nothing.”
“Hmmm.”
“But what happened was that on the whole, the prices of a lot of the stocks he had invested in, kept falling. And you ended up with these sheets of paper.”
“Which I did.”
“As Daniel Kahneman, the Nobel Prize winning psychologist, writes in Thinking, Fast and Slow: “A rational decision maker is interested only in the future consequences of current investments. Justifying earlier mistakes is not among the…concerns. The decision to invest additional resources in a losing account when better investments are available, is known as sunk-cost fallacy, a costly mistake that is observed in decisions large and small.””
“That's interesting.”
“Kahneman gives the hypothetical example of a company that has already spent $50 million on a project. As he writes: “The project is now behind schedule and the forecasts of its ultimate returns are less favourable than at the initial planning stage. An additional investment of $60 million is required to give the project a chance. An alternative proposal is to invest the same amount in a new project that currently looks likely to bring higher returns. What will the company do? All too often a company afflicted by sunk costs…[throws] good money after bad rather than accepting the humiliation of closing the account of a costly failure.””
“So does the sunk cost fallacy apply to other aspects of life as well?” she asked.
“Of course it does. Take the case of something as simple as reading a book. Within the first 50 pages of the book it is more or less clear, whether we are liking the book or not. But even in situations when we are not liking it, we tend to complete reading it.”
“Oh yes, that's happened to me several times.”
“Escalation of commitment can go much beyond this. As Yuval Noah Harari writes in Homo Deus—A Brief History of Tomorrow: “Business corporations often sink millions into failed enterprises, while private individuals cling to dysfunctional marriages and dead-end jobs.””
“Jobs?” she asked.
“Yes jobs,” I replied.
The example is hypothetical.
(Vivek Kaul is the author of the Easy Money policy).