Have you ever heard of the Sunk Cost Fallacy? This psychological phenomenon is when you invest so much time or money, that you just refuse to abandon it or pull out. Even when you know that it’s better to abandon it. This applies to everything in your life, not just your investments. For example you devote a lot of time into a project even though you know the outcome will be a failure. Yet you still continue the project. Why do we do this? Often it’s because we already put so much time and effort into it might as well finish it. Also feelings of FOMO (fear of missing out) affect this too. What if it gets better? Ever stood in a line for something? If I leave now the line will probably move faster. I don’t know that for sure though. I already devoted so much time into waiting that I might as well keep waiting, even though I don’t want that coffee anymore. If I leave now I can still make it to work on time but I won’t have coffee, but also what if the line does move quicker? How is this supposed to affect your investment decisions though?

Fear of Missing Out

Everyone hates the fear of missing out. It’s one of the biggest leaders of why we say yes to everything. Even if we know it won’t always be good. Why is it that every time I go out with my friends nothing interesting happens. The one day I say no, they bump into a celerity and the bar gives out free drinks. Same with investments. The fear of missing out makes you make irrational investment decisions all because you’re afraid of missing out on the next Apple or Tesla. Your friend swears that this company is HUGE it’s only $0.50 a share now but will 100x soon! We cannot let FOMO affect our investment decisions, we have to learn to make rational choices on companies we believe in.

Cutting Your Losses

If you made a wrong investment decision it’s better to cut your losses and move on. Admitting you made a wrong choice is also difficult. Sometimes it’s better to sell at a small loss as supposed to letting it ride to $0. Although this is an extreme circumstance it’s a choice some people have to make. For example, a company you invested money on 5 years ago is trending downwards and heading for bankruptcy. You can sell now and cut your losses, or wait until it goes bankrupt. There are other investments you can make with that money but the sunk cost fallacy makes it difficult to sell. Now the FOMO and the money and time sunk into this investment have made it extremely difficult to sell. What if when I sell they improve their financials?

Accepting The Choice

Once you decided that it’s better to move on from a investment choice, it’s best not to look at it for a while. Sometimes you will be happy with your choice. Other times not so much. In my opinion It’s better to walk away with some of your money than none of it. There will be plenty of other opportunities to go invest into. It’s not the end of the world.

Exit Strategy

If emotions run into play, you can try an exit strategy. When going into an investment you can make a plan that you will sell if it reaches a certain price, no matter what. For example setting a stop loss order with your broker will automatically execute a sell on a stock once it reaches a price you set. If I buy a share of a stock at $100 I can set a stop loss at $90 and it will automatically sell at $90 limiting my losses. Same goes for a take profit order. If I’m happy with the stock reaching $110 and selling, I can tell my broker to automatically sell my stock at $110 a share and forcing my exit to take profit. This is good when you’re an emotional investor because it stops you from getting too greedy and guarantees a profit.

An exit strategy is usually for short term investors, but learning how to be a good short term investor teaches you to appreciate the wonders of long term investing. Even long term investors need to have an exit, and know when to take their profits and losses. Have you had any investments you had to cut your losses on?

Thank you for reading and see you next Sunday,
– Pablo