Saturday Serendipity
Quote, Mental Model,Interesting find.
Hi.
Reading time: About 6 minutes
Quote
"Do something original. Don’t run with the pack. If everyone is trying to solve the same problem ... don’t do that." ~Jim Simons
Jim Simons was the smartest investor the world has ever seen. He died recently. R.I.P Jim Simons :(
Mental Model
Sunk Cost Fallacy
Sunk cost is a concept from economics. It can be defined as:
‘A sunk cost is money that has already been spent and cannot be recovered. In business, the axiom that one has to "spend money to make money" is reflected in the phenomenon of the sunk cost.’ - Investopedia
I play cricket and I have captained a team in the past. Usually when you captain a game you have to make a lot of decisions in the spur of the moment. You don’t get a lot of time to think you have to be ready to adapt always. But you also have a lot of moments where you have a good amount of time to think. In my very limited experience, what I noticed was I many times made the wrong decision by giving a bowler an extra over or not changing the field too quickly, these are things which I planned early on but did not adapt to based on the situation. Now a good decision maker and a clear thinker would change his thought process based on the options and the situation. I however made a mistake. I decided that I have already given this person 2 overs and he has not bowled that well but I planned on giving him 3 overs so i’ll continue with him. Even though I knew that this person has not bowled well I stuck with my decision because in my plans and the effort of planning that went in before I decided that this person will get 3 overs. This is nothing but sunk cost fallacy.
Sunk cost fallacy is:
“The sunk cost fallacy is the tendency for people to continue an endeavor or course of action even when abandoning it would be more beneficial. Because we have invested our time, energy, or other resources, we feel that it would all have been for nothing if we quit.” Kassiani
If you have some sort of knowledge of human behaviour or have read my mental models you can easily relate my story to two more biases commitment bias and loss aversion. The fact that a story can be related to more than one mental model means we have in some manner improved our thinking.
Sunk Cost fallacy is dangerous because it affects your decision making drastically. Think about a small thing. I am an Indian. I have a mindset of if I have paid something then I have to make use of it. If I am going to an event and I have spent Rs600 for it and I don’t like the event I will still stay for the entire event even though I don’t like it because I paid for it. What I fail to realise in this scenario is the fact that the money is already gone. What I can save in this scenario is time. What usually happens is we think that we have to get some value out of this money. But we lose the value of time. I can’t count the instances where I have stayed through a movie just because ‘meine paisa bhara hai toh ab vasool karna padega’.
If you think about it this also lines up with the importance of time. We give more weightage to money in this scenario and end up wasting our precious limited time.
“The sunk cost fallacy is most dangerous when we have invested a lot of time, money, energy, or love in something. This investment becomes a reason to carry on, even if we are dealing with a lost cause. The more we invest, the greater the sunk costs are, and the greater the urge to continue becomes. … Rational decision making requires you to forget about the costs incurred to date. No matter how much you have already invested, only your assessment of the future costs and benefits counts.” - Ralf Dobelli , The Art of Thinking Clearly
So many times we do this when we are doing some project which we see is going nowhere special. We put in effort and midway you realise that the end result won’t be as great as you expected. You still end up finishing the mediocre project.
In Investing
Investing is not an easy task. You have to do a lot of research if you want to truly understand a business. Li Lu says if you want to be a great investor you have to be like a journalist trying to find out every single detail that you can. This task can take up a lot of time. You read all the annual reports, conference calls, broker reports, industry reports, etc. As an investor you spend hours and days on end to find out if a company is truly worth investing. Even Buffett reads a lot. So to be successful you have to read and put time in.
Now what we experience many times as investors is that after putting a lot of effort in we find out that the company is good and the numbers which are currently showing are sustainable and can be replicable in the future as well. You decide to invest. It turns out to be the right decision. You make some money. But what happens is after two years some change has happened. In some sense you know that the company has changed and you look into it. You find it to be a mediocre change which won’t affect the company much. You decide not to change your view which it took months and months on end to build. You stay invested. Turns out you were wrong. Company went backwards. Your thoughts were impacted by the fact that you did not want your past efforts to go to waste. Many times we put in the work and find a company to be average. Some people still end up investing because all the time that they put in, they don’t want that to go to waste.
As Ralf Dobelli said , the more time and effort that is put in the higher the sunk cost.
Someone once said that reading about businesses is almost never a waste of time because even if you don’t like the business you read the knowledge that you got may end up helping you in the future in some other business. And that is what I believe is a good way to think to avoid sunk cost. Don’t think that you have lost your time because you read a lot on a mediocre business. You learnt something and whatever you learnt will help you in the future. That’s how knowledge works.
(P.S I couldn’t find the exact quote so if you have the quote plese do add it in the comments)
Interesting find
Thanks for reading,
Samvit.