Sunk Cost Trap

What Is a Sunk Cost Trap?

Sunk cost trap alludes to an inclination for individuals to unreasonably follow through on an activity that isn't meeting their expectations. This is a result of the time as well as money they have proactively invested. The sunk cost trap makes sense of why individuals finish films they are abhorring, finish feasts that taste terrible, keep garments in their closet that they've never worn and hold on to investments that are failing to meet expectations. The sunk cost trap is additionally called the Concorde fallacy after the failed supersonic Concorde fly program that funding legislatures demanded finishing in spite of the stream's poor outlook.

How a Sunk Cost Trap Works

Investors fall into the sunk cost trap when they base their decisions on past ways of behaving and a longing to not lose the time or money they have proactively invested, rather than cutting their losses and pursuing the choice that would give them the best outcome going ahead. Numerous investors are hesitant to concede, even to themselves, that they have made a terrible investment. Changing strategies is seen, maybe just subliminally, as conceding disappointment. Thus, numerous investors will more often than not stay committed or even invest extra capital into a terrible investment to go with their initial choice appear to be worthwhile.

Illustration of the Sunk Cost Trap

Jennifer buys $1,000 worth of Company X's stock in January. In December, its value has dropped to $100 even however the overall market and comparable stocks have risen in value over the course of the year. Rather than selling the stock and putting that $100 into an alternate stock that is probably going to rise in value, she holds on to Company X's stock, which before long becomes worthless.

Keeping away from the Sunk Cost Trap

The best method for keeping away from the sunk cost trap is to set investment objectives. To do this, investors could set a performance target on their portfolio. For instance, investors could look for a 10% return from their portfolio over the course of the next two years, or for the portfolio to beat the Standard and Poor's 500 index (S&P 500) by 2%. Assuming the portfolio neglects to accomplish these objectives, it very well may be reconsidered to see where upgrades could be made to accomplish better returns.

In the event that investors are trading individual stocks, they might have a foreordained exit point before entering a trade. This serves to consequently cut losing positions and stay away from the inclination to commit additional time and capital to investments that aren't working.