Latest / Behavioral Economics with Fexingo: Decision Making, Bias, and How People Really Spend / The Sunk Cost Fallacy in Your Investment Portfolio
Transcript
- Lucas: There is a specific kind of pain that comes with watching a stock you bought three years ago bleed out value. It’s not just about the money; it’s about the story you told yourself when you made that purchase. And yet, despite the red ink, millions of investors refuse to sell, clinging to the hope that the narrative will rewrite itself. Luna: Right, because selling feels like admitting you were wrong about everything. So the brain chooses the pain of loss over the ego death of being incorrect. Lucas: Exactly. That is the core of the sunk cost fallacy. We’ve talked about mental accounting and loss aversion, but this is different. This is about how past investments become anchors that prevent rational future decisions. Today, we’re looking at why people hold onto dying assets instead of cutting their losses. Luna: It’s the digital equivalent of keeping a broken pair of shoes because they were expensive. You wear them until your feet bleed, telling yourself they’ll break in eventually. Lucas: That’s a perfect analogy. In finance, we call this disposition effect. Investors tend to sell winners too early to lock in a sense of pride, while holding losers too long to avoid realizing a mistake. Let’s look at a concrete example from the last quarter. A mid-cap tech firm saw its product line fail, revenue dropped by twenty percent year-over-year, and guidance was cut. Fundamentally, the thesis was broken. Luna: So why didn’t the average holder sell? Because they were waiting for the price to get back to their buy-in point. Lucas: Precisely. They are anchored to the entry price, not the current reality. The money is gone. It is a sunk cost. But psychologically, it still feels like it belongs to them. So they wait for a rebound that might never come, hoping to exit at breakeven. Meanwhile, better capital allocation opportunities are passing them by. Luna: It’s like staying in a bad relationship because you’ve already invested five years. You tell yourself the time spent counts toward the future, but it doesn't. It’s just history. Lucas: And that is the dangerous part. The time is gone. But staying costs you more time. In business, we see this with project management all the time. Companies pour millions into a failing software launch because they don’t want to write off the initial development budget. They keep feeding it to justify the past spend. Luna: Which usually means they waste twice as much on something nobody wants. The board loves a hero who saves the day, but hates a manager who cuts the cord. Lucas: Right. There is no award for saving a zombie project. There is only the P&L statement. Yet, emotionally, admitting failure feels catastrophic. Researchers found that investors who held onto losing positions for an extra six months often saw those positions drop another fifteen percent. They sacrificed future gains for present comfort. Luna: So the question is, how do we trick our brains into accepting that the past is dead? Can we separate the decision from the emotion? Lucas: One method is what I call the zero-based review. Instead of asking if you should sell because you’re down ten percent, ask if you would buy this asset today at its current price. If the answer is no, then you should sell, regardless of your entry price. It forces you to look forward, not backward. Luna: That’s brutal. Because most people would say no. They’d realize the company has lost its edge. But then they add, well, I’d need it to go up first. Lucas: Exactly. That conditional hope is the trap. Let’s talk about the scale of this. In 2025, data showed that retail investors held onto underperforming assets for an average of forty days longer than institutional traders. That’s over a month of missed opportunity cost. If that capital had been deployed into a broad market index, it would have grown significantly. Luna: Forty days sounds short, but in a volatile market, that’s where the compounding happens. You’re missing the recovery phase because you’re stuck in the decline phase. Lucas: And it’s not just stocks. Think about your career. How many people stay in roles they hate because they spent four years getting the degree? The degree is the sunk cost. The labor market is the current reality. Staying in a misfit job to justify the tuition is a classic error. Luna: I see that in my network all the time. People pivot slowly, painfully, because they feel guilty leaving behind the path they mapped out a decade ago. The map is irrelevant now. Lucas: It is irrelevant. The world has changed. Skills have depreciated or appreciated differently. We need to update our internal ledger constantly. But humans are terrible at updating ledgers. We prefer the comfort of consistency. We want our past selves to be right. Luna: Because if our past selves were wrong, then maybe our current judgment isn't trustworthy either. It undermines confidence. Lucas: That’s the hidden cost. It erodes self-trust. Every time you hold a loser hoping for a miracle, you reinforce the habit of irrationality. Over time, that becomes a pattern. You start applying it to other areas. You ignore warning signs in other parts of your life because you’re trained to wait out the storm. Luna: So the fix isn't just financial discipline. It’s cognitive humility. Admitting you don't know everything, and that yesterday’s wisdom might be today’s noise. Lucas: Yes. And one practical tool is setting hard rules before you enter a position. If you decide upfront that you will sell if X happens, you remove the emotion from the moment of crisis. It’s easier to follow a plan made in calm waters than in a hurricane. Luna: Like a stop-loss order. But applied to your whole life strategy. If the metric changes, the action changes. No negotiation. Lucas: No negotiation. Let’s pause here for a second to talk about how this show works. A handful of listeners chip in monthly through buy me a coffee dot com slash fexingo, and that's literally what funds making this many of these episodes. It keeps us independent and ad-free, which lets us dig into topics like this without corporate interference. Luna: Yeah, if walking through the economy with us has made something click, consider supporting the work directly. It helps us keep the lights on and the research deep. Lucas: Thank you to everyone who already contributes. Now, let’s get back to the market. Another layer of this bias is social validation. Investors often check forums or news headlines to confirm their holdings are safe. If everyone else is holding, they feel less alone in their mistake. Luna: The herd protects the individual. It’s safer to lose money together than to be the lone genius who sold early and watched it rally. Lucas: That’s regret minimization. We fear the regret of acting too soon more than the regret of acting too late. But in finance, acting too late is often more costly. Let’s look at a specific case from last year. A consumer goods company launched a new product line that failed to gain traction. Sales were flat. Management blamed supply chain issues, not product fit. Luna: Blaming external factors is the easiest way to avoid accountability. So investors kept buying the dip, thinking it was a temporary setback. Lucas: It wasn’t temporary. It was structural. The brand had lost relevance with younger demographics. But the chart looked pretty for a few months. So people bought. By the time the earnings miss came, the stock had dropped thirty percent. Those who sold earlier could have preserved capital. Those who held suffered the full brunt. Luna: So the lesson is, ignore the chart if the fundamentals are rotting. The price is just a reflection of what people think, not what is true. Lucas: Exactly. Price is lagging. Fundamentals are leading. When you focus on the price, you fall for the sunk cost. When you focus on the business, you make rational decisions. It requires you to do the homework. Read the reports. Understand the product. Don’t just watch the ticker. Luna: It’s harder work. But it’s the only way to avoid being hostage to your own past choices. You have to be willing to be bored. Rational investing is boring. Lucas: Boring is profitable. Exciting is expensive. If you find yourself excited about holding a losing stock, you’re probably doing it wrong. Ask yourself if you’d buy it today. If not, sell it. Cut the anchor. Move on. Luna: It’s a liberating thought. Once you accept the loss, you’re free to find the next win. You’re not carrying baggage anymore. Lucas: Exactly. The baggage was always there. You just couldn’t see it because you were busy trying to carry it. What’s the next move for you? Is there something you’re holding onto just because it was once valuable?