The ABCs of Behavioral Biases (S-Z)

The ABCs of Behavioral Biases (S-Z)

We are coming in for a landing on our alphabetic run-down of behavioral biases. Today, we will present the final line-up of sunk cost fallacy and tracking error regret.

Sunk Cost Fallacy

What is it? Sunk cost fallacy makes it harder for us to lose something when we also face losing the time, energy or money we have already put into it. In “Why Smart People Make Big Money Mistakes,” Gary Belsky and Thomas Gilovich describe sunk cost fallacy as “the primary reason most people would choose to risk traveling in a dangerous snowstorm if they had paid for a ticket to an important game or concert, while passing on the trip if they had been given the ticket for free.” You are missing or attending the same event either way. But if a sunk cost is involved, it somehow makes it more difficult to let go, even if you would be happier without it.

When is it helpful? When a person, project or possession is truly worth it to you, the blood, sweat, tears, and/or legal tender you have already poured into them can help you take a deep breath and soldier on. Otherwise, let’s face it. There might be those days when you would be tempted to help your kids pack their “run away from home” bags yourself.

When is it harmful? Falling for financial sunk cost fallacy is so common, there is even a cliché for it known as throwing good money after bad. There is little harm done if the toss is a small one, such as attending a prepaid event you would rather have skipped. But in investing, adopting a sunk cost mentality can prevent you from selling an existing holding once it no longer belongs in your portfolio. For better or worse, you cannot go back in time and alter what you have already done with your investments. But you can keep your portfolio optimized for capturing future expected returns according to your own goals and the best evidence available to us today.

Tracking Error Regret

What is it? If you have ever decided the grass is greener on the other side, you have experienced tracking error regret, otherwise known as that gnawing envy you feel when you compare yourself to external standards, and wish you were more like them.

When is it helpful? If you are comparing yourself to a meaningful benchmark, tracking error-regret can be a positive force, spurring you to try harder. Say, for example, you are a professional athlete, and you have been repeatedly losing to your peers. You may be prompted to embrace a new fitness regimen, rethink your equipment or otherwise strive to improve your game.

When is it harmful? If you have structured your investment portfolio to reflect your goals and risk tolerances, it is important to remember that your near-term results may frequently march out of tune with other returns, and by design. It can be deeply damaging to your long-range plans if you compare your own performance to irrelevant, apples-to-oranges benchmarks such as the general market, the latest popular trends or your neighbor’s seemingly greener financial grass. Stop playing the shoulda, woulda, coulda game. Stop chasing past returns you wish you had received based on false benchmarks. Other people’s goals differ from yours. Tend instead to your own personalized planning, evidence-based investing and appropriate benchmark comparisons.

We have now reached the end of our alphabetic overview of the behavioral biases that most frequently lead investors astray. In a final installment, we will wrap everything up with a summary. Until then, no regrets!

This post was written and first distributed by Wendy J. Cook.


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