For Humans, mental accounts are a form of narrow framing; they keep things under control and manageable by a finite mind.
The decision to invest additional resources in a losing account, though better investments are available. This is known as the sunk-cost fallacy, a costly mistake that is observed in decisions large and small.
Many financial institutions refinance bad loans with the hope of recovering them. If the company starts doing well through an additional loan then should give an additional loan rather than book it as an NPA. This will result in a larger bad loan on the book of institutions.
We have seen that loss-making business or division keeps getting funds from the bank or financial institutions. Also, many non-performing banks keep getting recapitalization from the government. This is an example of a fall of government into the sunk cost fallacy. We have seen in “Mahabharata” that King Yudhishthira keeps on gambling with the hope of winning everything back. He considered his brothers and wife as an available resource and played for winning back his lost fortune.
Investment – When we have invested in a few stocks and those turn out to be our mistakes but we resist booked losses from it. We think that if we book losses then it will occur but we do not think that loss already occurs, just we have not accepted it. A common practice by the majority of investors follow is to book winners and hold on with losers or average losers.
The sunk cost fallacy is most dangerous when we have invested a lot of time, money, energy, or love in something. We carry out with the burden of losses and invest more in it. As we invest more, we fall further into the trap of sunk cost fallacy and cannot take the exit with losses. This is irrational. I have seen many fund managers/research analysts who cannot reject ideas after they have made good efforts, though they found something wrong about their investment idea.
Overcoming a Sunk cost fallacy, we have to understand that the acquisition price has no role to play while making an investment decision. What counts is the stock’s future performance (and the future performance of alternative investments). So that if we feel that stock is more valuable and have the potential to perform well in the future based on its fundamental (not on basis of gut feelings) from current price then only we have to hold it or invest in it. We have to delete buy price column or have to ignore it. If we have found that business has some problem and will not grow it or will not sustain then we must have to take exit because holding that will defiantly going to give us a permanent loss of capital.
We can see in the mentioned link that the public has increased their holdings in stocks which have eroded wealth.
QUALITY INVESTING CAN BE A CONTRARIAN INVESTING….
This entire series will be review with various examples from books which are “Thinking, Fast and Slow” and “The Art of Thinking Clearly“.