In 1962, the British and French governments signed an agreement to collectively research and develop a new type of aircraft – Concorde – which would revolutionise air travel.
According to Simple Flying, initial estimations set the budget for the project at $130 million. However, costs soon started to spiral, and critics raised questions about whether the aircraft would ever be profitable. Many suggested the project be abandoned.
Yet, the British and French governments pushed on as they’d already invested so much, and the total cost of developing Concorde eventually reached more than $2.8 billion.
Despite not being profitable, Concorde did make commercial flights for 27 years, starting in 1976. It was eventually retired in 2003, as it never became financially viable. Had the governments listened to their critics and ended the project earlier, they could have saved billions.
The Concorde project goes down in history as a prime example of the “sunk cost fallacy” – the reluctance to abandon a course of action because we’ve already invested time or resources in it.
The sunk cost fallacy could affect many decisions you make in life, especially those to do with your investment portfolio.
Read on to learn more about the sunk cost fallacy and how avoiding it could improve your investment strategy.
The sunk cost fallacy could prevent you from abandoning an unproductive course of action
The sunk cost fallacy is a logical misjudgement that causes you to continue with a certain course of action because you’ve already invested time or resources in it. You might do this even if abandoning the action would ultimately benefit you.
For example, imagine you see a film at the cinema and half an hour in, realise that you’re bored and not having a good time at all. If you leave, you could go and spend that time doing something more enjoyable.
Yet, you might decide to stay because you’ve bought the ticket. This is the sunk cost fallacy at work. You feel you should stay because you’ve already invested time and money.
However, regardless of whether you stay for the rest of the film or leave early, you won’t get your money back. So, there is no logical reason to spend two hours watching a film you don’t enjoy. Despite this, the sunk cost fallacy might make you feel that you want to “get your money’s worth”.
The sunk cost fallacy may also be caused by another psychological trait called “loss aversion”. This is the tendency to feel the pain of a loss more acutely than the pleasure of a gain.
Abandoning a course of action can sometimes feel like a loss. For instance, you might perceive that leaving the cinema early means you’ve “lost” the money for the ticket, while staying until the end doesn’t.
The sunk cost fallacy may affect your investment behaviours and potentially dampen your returns
Market volatility is a natural part of investing, and you’ll likely see the value of your assets rise and fall over time. Often, when the value of your portfolio dips, it may be best to hold your investments and take a long-term approach because markets typically bounce back and continue growing.
However, there are some instances where a certain investment or strategy simply isn’t offering the growth that you require and could lead to significant losses.
For instance, you might be investing in a sector that is no longer profitable as technology or consumer trends change. Alternatively, you may invest in a fund that is generating minimal returns, making it more difficult to meet your long-term goals.
In these situations, it could be beneficial to cut your losses and adopt a new strategy. Unfortunately, this is where the sunk cost fallacy comes into play.
If you’ve already invested a significant sum over many years, you might be more inclined to hold out, even if you’re not generating the returns you need. Also, if you experience losses, you might decide to continue investing in the hope of recouping those sunk costs.
Meanwhile, changing course and investing elsewhere might feel like accepting the loss, and this can be difficult.
However, it’s important to focus on your goals. Continuing with an investment strategy that isn’t working for you could mean that you’re unable to meet your long-term goals and enjoy your dream lifestyle in retirement.
Conversely, if you can overcome the sunk cost fallacy and accept some losses now, you might be able to pursue a new investment strategy that provides greater returns moving forward. Ultimately this could mean that you’re more likely to achieve your long-term goals, despite short-term losses.
Professional advice can help you avoid the sunk cost fallacy
Professional advice is incredibly valuable when deciding whether you should stay the course or adopt a new investment strategy.
In some cases, we might offer reassurance during a period of volatility and recommend that you simply wait for markets to bounce back because you’re still on track to meet your goals.
On the other hand, if certain investments are consistently generating losses or failing to offer the returns you need, you might fall victim to the sunk cost fallacy and be tempted to continue investing regardless.
We can offer impartial advice and help you create an alternative investment strategy that supports your long-term goals.
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Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
All information is correct at the time of writing and is subject to change in the future.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.