Why do bad financial things happen to wealthy people?
People don’t act like financial calculators when it comes to their finances. This holds true no matter what their income is or where it comes from. We’re subject to biases and psychological fallacies that, if we understand them, can help us as to manage our money better.
Take the notion of “sunk costs.” If you start a project, you tend to keep going, even if you know that future efforts are likely to be worthless. We don’t want to “waste” all that time and energy that we put into the project in the past—even though that time is already wasted. What matters is the future cost. If we go to a movie, and it’s dreadful, we’re still unlikely to walk out—even though the ticket price and the time we’ve already spent are gone.
The same applies to investments. If you buy a stock, and it goes down, you’re far more likely to hold onto it and wait to “get back to even” than if the stock simply went sideways. We tend to feel a personal attachment to our own holdings—even when, rationally, there’s nothing special about my purchase price. It’s special to me, that’s all. But a stock doesn’t know that you own it, and the future price has no relation to your particular costs basis.
Knowing your own biases can help you be a better investor. It can also help you avoid wasting your time and talents on fruitless activities.
Douglas R. Tengdin, CFA
Chief Investment Officer
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