I don’t want to sound too “new school” here, but too often our decisions about the future are bogged down by our actions in the past. People stay in unsatisfying careers because of the time and money they invested in their education, not because they enjoy the work or even expect to in the future.
For example, we finish a bad book because we’ve gotten so far, not because we’re anxious to see what the outcome may be; we sit through a boring movie because we bought a ticket, not because it’s a good flick. Good or bad, those same motivations affect our decisions about money. We spend more money on car repairs because we’ve already spent so much on the car itself. We keep spending money on golf lessons (at least I do) because we’ve already spent so much. I think you get the point I am making here.
The same principles apply to investing or committing capital to the markets for longer periods of time. We hold on to bad trades because we can’t get over how much we’ve paid for them already and can’t bear to make that bad trade final. Well, it’s essential to get over it!
I’m not trying to be harsh or even tell you that I haven’t committed this mistake myself because I have. If it was possible to take a pill that erases the memory of every dollar you have ever spent (except perhaps, when filling out expense reports and tax returns). That’s because once you’ve spent it, it’s gone. It has no relevance. To the extent that you can incorporate that notion into your financial decision making process, you will be that much better off for trying. If you’re debating the sale of an investment, a home for example, remember that your goal is to maximize your wealth and your enjoyment. The goal is to not justify your decision to buy the investment at whatever price you originally paid for it. Who cares? What counts, in terms of getting where you want to be tomorrow, is: what the investment is worth today? That’s why you must evaluate all trades and investments (and expenses) based on their current potential for future loss and future gain.
So, how does one go about forgetting the past? One helpful device is a method of reframing decisions to remove emotional investments. Call it, “pressing the rewind button.” Assume that you can reverse history and start anew. Here’s how this might work.
Imagine that you have a 10 year old minivan that needs a new transmission. The sunk cost fallacy tell us that you’re more likely to plunk down the cash to buy the new transmission if you’ve recently sunk hundreds or thousands on repairs to your clunker. So ask yourself: If someone gave you the minivan as a gift yesterday, would you spend the money today to get it running? If the answer is “no” because that large an investment is not worth it on its merit then it’s probably time to think about getting a new car. Similarly, it is relevant only to your ego that your XYZ stock for example, for which you paid $100 a share, is now selling for $25 a share. If you believe it’s a bargain, hold on and maybe even buy some more shares. But if it is not – if, given the chance, you would pass on the opportunity to buy the same shares at any given price today than it is time to sell. So ask yourself when evaluating investments, “Would I buy this today, at this price?” If not, you may or may not want to own it longer.
By: Evan Lazarus
Disclosure: No relevant positions