Sunday, October 6, 2013

Forget What The Home Cost: The Sunk Cost Fallacy

The mood was dire, a husband shouts to his wife
 “We are selling this home!” She replies: “No way,

We are not throwing away the money we have already invested in it.”

A real estate agent's marketing campaign to sell a home had been running for two months and had not
netted the desired results. He was in favor of scrapping it.

The homeowner (his client) however
resisted, saying: “I will not come down from the current price and we have already invested so much
time into this. If we stop now, it'll all have been for nothing.”

Both are victims of the Sunk Cost Fallacy.

The sunk cost fallacy arises whenever we have invested a lot of time, money, energy or love into
something. Our initial investment becomes a reason to carry on, even if we are dealing with a lost
cause. The more we invest, the greater the sunk cost becomes, and the greater the urge to continue
also becomes.

Investors frequently fall victim to the sunk cost fallacy just as much or perhaps even more so than
others. Often they base their investment decisions on the acquisition price. “I have already lost so
much money, I can't sell it now.” This of course is wholly irrational. The initial acquisition price
should play no role in follow-on decisions whatsoever. The intrinsic value and its future prospects are
what counts. Though rather ironically, the more money an investment loses, the more investors tend to
cling to it.

This irrational behavior stems from the human need for consistency and from the tough
time we have with changing our minds and admitting that we once thought differently (Inability to
Close Doors) itself a logical fallacy and thinking error.

In conclusion, there may be good reasons for homeowners or investors to continue investing in
something, but beware of doing so for the wrong reasons, such as to justify non-recoverable costs.
Truly rational decision making requires one forget about the initial costs incurred, no matter the sum
and keep in mind that only a fair assessment of intrinsic value and future benefits counts.

Laureen Trent , Trent Realty Florida  


Theodor Tonca: :  Writer, businessman,entrepreneur, CEO of Graham Theodor, supporter of the Austrian School of Economics
Hal R. Akres & C. Blumer “The Psychology of Sunk Cost” Organizational Behavior & Human Decision Processes 35, 1985.
Rolf Dobelli “The Art of Thinking Clearly” (New York: HarperCollins, 2012)

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