Have you ever noticed that something you put a lot of time and effort to acquire feels more valuable than something that came easily to you? Maybe you’ve been stuck in traffic and experienced a twinge of envy when comparing your car to a high-end sports car.If you can relate, we think you may find today’s post about behavioral biases particulary insightful. Let’s examine the last of our Behavioral Biases A-Z: sunk cost fallacy and tracking error regret.
Even when we understand the importance of crafting our personal wealth journey around our goals and values, it can be all too easy to fall into the potholes created by behavioral biases along the way.
SUNK COST FALLACY
What is it?
Sunk cost fallacy happens when we are more attached to something because of the time, energy, and also the money we put into it. Gary Belsky and Thomas Gilovich write in Why Smart People Make Big Money Mistakes: “[Sunk cost fallacy] is the primary reason most people would choose to risk traveling in a dangerous storm if they had paid for ticket to an important game or concert, while passing on the trip if they had been given the ticket for free.” The outcome is the same (attending or not attending), but the process (paying for it yourself) is different.
When is it helpful?
When something or someone seems truly worth it, the sunk costs of effort, time, and/or money can help us stay committed. Relationships, especially parenting, wouldn’t stand up to a cold cost/benefit analysis, the “sunk costs” of emotion, memory, and sweat and tears, help to keep relationships going.
When is it harmful?
Everyone knows the old adage about throwing good money after bad. This describes the all-too-common problem of the sunk cost fallacy in finance. Sometimes the money we “throw” is a small amount, such as driving through the storm to an event in our previous example. But when it comes to our finances, making decisions based on this frame of mind (i.e. “I can’t unload this until I’ve at least broken even”), may end up costing real dollars by delaying us from taking a course of action that aligns with our risk tolerance and goals.
TRACKING ERROR REGRET
What is it?
If you’ve ever peered over the fence to see the greener grass on the other side, you’ve experienced tracking error regret. This is the sometimes painful envy you feel when comparing yourself and your situation to someone else and wishing your grass had that kind of green.
When is it helpful?
When your checking yourself against a verifiable standard, tracking error regret can be a catalyst to better and stronger efforts. If you’re a professional athlete who keeps losing, you may be inspired to change your workout routine, re-double your efforts, and sharpen your game.
When is it harmful?
Your long-range plans can suffer if you change course after comparing the performance of your portfolio to the latest investing fads, the general market, and that mythical “greener grass” we all seem to be looking for.
Hopefully, you have a better idea of what behavioral biases to look out for on your wealth journey. We’ll wrap up this series in the next post when we share our concluding thoughts about how you can help keep behavioral biases from throwing you off track.
