Dear Patrons,
Jimmy and his tennis elbow
Jimmy paid Rs.1,00,000 to an indoor tennis club that entitled him to play once a week for the indoor season. After two months he developed tennis elbow, which made playing painful. He continued to play in pain for three more months because he did not want to waste the membership fee. He only stopped playing when the pain became unbearable.
When an amount of money has been spent and the money cannot be retrieved, the money is said to be sunk, meaning gone. Expressions such as “don’t cry over spilt milk” and “let bygones be bygones” are another way of putting economist’s advice to ignore sunk costs. But this is hard advice to follow, for example, leaving a boring movie in between or selling non-performing assets.
To make things clear, let’s stipulate that if a friend invited Jimmy to play tennis (for free) at another club, Jimmy would say no because of his painful elbow. For him, the utility of playing tennis with painful elbow is negative. But having paid Rs.1,00,000, he continues to play, seemingly making himself worse off every time he does so.
There are dozens of examples of people paying attention to sunk costs. One involved a friend, who was in argument with his son who wants to play cricket while he wanted his son to play football. That friend already bought football kit for his son. If the son continues to play cricket than football kit goes to the waste. To save what he spent for the kit, he wants his son to change interest of the game. This is falling for sunk cost.
Investors fall for sunk costs many often. Anyone who trades in stock market has portfolio with Sunk Costs. Many stocks / funds are in the portfolio with comparatively less yield than others. But it is not easy to get rid of them. Investors still keep holding them with view that it will someday regain its glory which never happens. At Shalibhadra, portfolio review and reshuffling is one of the priority. Investing and Reinvesting is two sides of a coin and equally important.
Nishit Siddharth Shah