The Sunk Cost fallacy describes the irrational behavior where people who have invested time or money decide to “follow through on their losing endeavors” despite their previous losses. The sunk cost fallacy is the reason why gamblers “chase their losses” often by making increasingly bigger and riskier bets.
The Two Gamblers
On this post, we will look at two hypothetical gamblers, a conservative gambler who spreads their money around and plays the odds and a Gambler who is willing to bet it al because You Only Live Once (YOLO). In this scenario, the yolo gambler will almost lose more money and end up broke faster than a gambler who consistently makes calculated conservative bets.
If given the same amount of betting money, the conservative gambler increases their chances of winning more (or losing less) by spreading his smaller bets evenly. The gambler who increases his bet after every loss makes increasingly riskier bets and YOLO’s their money away in hopes of a single big payout.
Q: So who’s the better gambler?
A: I don’t know and it doesn’t matter.
If both gamblers refuse to cut their losses and stop gambling, they both will eventually lose. The sunk cost fallacy is what keeps gamblers gambling even though they have already won/lost money.
The Difference :Gambling VS Investing
The stock market is full of investors who pretend that they are gamblers and gamblers who like to pretend that they are investing.
“One of the key differences between investing and gambling is diversification. Investing provides you with the opportunity to spread your risk across all asset classes, whereas gamblers throw their capital into a single pot with no loss mitigation strategy.” Prudential Investment Managers
When you invest in the stock of a single company, one of the most important things to consider is the price that you purchased the stock at. That price, the price you pay, is your entry point.
Your stock entry point is important because that price will be the benchmark that you measure your gains or losses against.
Entry points are very important to strategic investors, who strategically plan the entry points and exit price of their investments. Value investors, chart readers, and market timers all use different methods to select their buy and sell prices, but they all have the same goal – to get the most out of their trades.
Investors who plan their entry and exit prices are less likely to incur large losses, not because they always pick better stocks, but because they generally avoid falling into a sunk cost trap by setting and sticking to their predetermined buy and selling price targets.
Sunk cost most often come into play when investors choose not to sell a stock that has declined or purposely chose to overpay for a stock that they we’re willing to “at any price”.
Avoiding sunk cost may sound simple, but when your time, money, or anything that you value is on the line, cutting your losses can be psychologically and emotionally taxing. Sunk cost are why people have trouble getting out of toxic relationships and leaving the jobs they hate.
As Cormac McCarthy says in No Country for Old Men “All the time you spend trying to get back what’s been took from you there’s more goin out the door. After a while you just try and get a tourniquet on it.”
⚠️Warning: This is not investment advice