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My impression of a sunk cost goes something like this — there’s a concert in town that you really want to see, so you buy a ticket. When you arrive at the concert you are informed that your ticket is a fake. You, however, have enough money in your pocket to buy a valid ticket - do you pay for the ticket and enjoy the concert or do you turn around and go home?
Thank you, David. I just sent a contextual letter and the same link to my 63 year old sister who owns a house in Miami Beach. Mitigating losses in the face of rising sea levels seems prudent.
The idea of sunk costs applies as much to liquid assets like fund shares as to less liquid assets like the real estate mentioned in the article.
Once you invest $1K in a fund, that cash is gone; what you have is N shares. Aside from tax implications, there's no reason to continue holding shares until you break even. Whether you are up 20% or down 10% doesn't matter, because that calculation is based on a sunk cost that you can't do anything about. What matters is whether the fund is something you would buy today.
The same holds true for individual bonds. Again disregard tax and transaction costs for simplicity. If you hold to maturity, you won't "lose money". But whatever you paid for the bond is gone. What you have today is a bond with a given coupon and a given maturity (or call) date and a current market price. The question is not whether you have lost money to date, but rather would you buy that same bond today at its current price? If not, if you could do better elsewhere, then why continue holding the bond?
Of course transaction costs and tax implications shouldn't be ignored. They add friction, so that it's not enough to say you could do something better with the value of the asset. A change has to make enough of an improvement to overcome that friction. Hence instead of two choices, buy or sell, there are three options, buy, sell, or hold.
For me, and I suspect for some others, the experience of sunk costs includes (with losers) not selling (= holding), not buying more, of course, and also feeling 'Of course I might buy it now; it's so cheap.'
Which is why the overseas RE and student bidding stories were (for me) so instructive.
I'm totally changing the subject here, I admit. Just to say something interesting. Well, interesting to me anyway.
There is an old concept in accounting of a "sinking fund". The value sinks as payments are made out, and eventually its value is totally "sunk" down to zero. This is what Lincoln was referring to in his second inaugural address:
To wit:
Fondly do we hope, fervently do we pray, that this mighty scourge of war may speedily pass away. Yet, if God wills that it continue until all the wealth piled by the bondsman's two hundred and fifty years of unrequited toil shall be sunk, and until every drop of blood drawn with the lash shall be paid by another drawn with the sword, as was said three thousand years ago, so still it must be said "the judgments of the Lord are true and righteous altogether."
Before I learned this, I had always pictured treasure piled onto a sinking ship or something.
1. Your first lost is your best lost. 2. Evaluate every strategy not just on a benefit of being right basis, but more importantly on the cost of being wrong basis. Sometimes its not always how much you can make, its how much you don't lose. 3. Behavioral Economics high level summarization: overconfidence is the #1 enemy.
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https://en.wikipedia.org/wiki/Sunk_cost
Once you invest $1K in a fund, that cash is gone; what you have is N shares. Aside from tax implications, there's no reason to continue holding shares until you break even. Whether you are up 20% or down 10% doesn't matter, because that calculation is based on a sunk cost that you can't do anything about. What matters is whether the fund is something you would buy today.
The same holds true for individual bonds. Again disregard tax and transaction costs for simplicity. If you hold to maturity, you won't "lose money". But whatever you paid for the bond is gone. What you have today is a bond with a given coupon and a given maturity (or call) date and a current market price. The question is not whether you have lost money to date, but rather would you buy that same bond today at its current price? If not, if you could do better elsewhere, then why continue holding the bond?
Of course transaction costs and tax implications shouldn't be ignored. They add friction, so that it's not enough to say you could do something better with the value of the asset. A change has to make enough of an improvement to overcome that friction. Hence instead of two choices, buy or sell, there are three options, buy, sell, or hold.
Which is why the overseas RE and student bidding stories were (for me) so instructive.
There is an old concept in accounting of a "sinking fund". The value sinks as payments are made out, and eventually its value is totally "sunk" down to zero. This is what Lincoln was referring to in his second inaugural address:
To wit:
Fondly do we hope, fervently do we pray, that this mighty scourge of war may speedily pass away. Yet, if God wills that it continue until all the wealth piled by the bondsman's two hundred and fifty years of unrequited toil shall be sunk, and until every drop of blood drawn with the lash shall be paid by another drawn with the sword, as was said three thousand years ago, so still it must be said "the judgments of the Lord are true and righteous altogether."
Before I learned this, I had always pictured treasure piled onto a sinking ship or something.
2. Evaluate every strategy not just on a benefit of being right basis, but more importantly on the cost of being wrong basis. Sometimes its not always how much you can make, its how much you don't lose.
3. Behavioral Economics high level summarization: overconfidence is the #1 enemy.