In our house, we like to do spring cleaning in the fall. So, while we were in the garage going through all the plastic toys we wanted to throw away, we started discussing how much we had already spent on them. It felt like a shame to discard items that cost us so much money.
Suddenly, a light bulb went off! I remembered learning about the "sunk cost fallacy" during my CPWA studies.
Definition:
Individuals commit the sunk cost fallacy when they continue a behavior or endeavor due to previously invested resources (time, money, or effort) (Arkes & Blumer, 1985). This fallacy is closely tied to loss aversion and status quo bias and can be viewed as a bias stemming from ongoing commitment.
We found ourselves hesitating to throw away old plastic toys simply because we had already spent money on them! What a waste, right?
NO! Not a waste, but actually very productive. By recognizing and admitting our behavioral bias (the sunk cost fallacy), we were able to pause, rethink our approach, and modify our behavior! That’s a real breakthrough! The result? Less clutter, a more organized garage, reduced stress, and a happier home!
In investment and wealth planning, we use the same principles. I often encounter the sunk cost fallacy with many clients. For instance, I have a current client who refuses to liquidate a long-held stock that has not contributed to their net worth. It hasn't grown, doesn't generate income, and offers no tax benefits. Yet, because they bought the stock years ago and invested significant assets, they are holding onto a loser = sunk cost fallacy.
The takeaway from this experience is that we all have biases (and if you think you don’t, that’s called overconfidence bias). The strength lies in being able to:
- Recognize the bias
- Admit you have one
- Redirect your resources if appropriate.
In my practice, which involves working with families who have significant assets and complex situations, recognizing emotional and cognitive biases not only leads to fascinating conversations but also improves the chances of achieving positive outcomes.
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If you think you would benefit from a conversation, feel free to reach out to me directly atPhil@ClarkWP.com.