Freakonomics recently resurfaced an old podcast about the upside of quitting. And while they cover a lot of strange “quitters,” from Amish women to baseball players, they oddly never touch on stock market investors.
I will, because the connection is clear when you look at just one single thought from the Freakonomics team: “Sometimes quitting is strategic, and sometimes it can be your best possible plan.”
Everywhere you look in the investing world, there are examples of how we change our behavior based on sunk costs (losses or expenses that cannot ever be recovered) and how we often overlook the opportunity cost (lost opportunities based on resources spent for one enterprise vs. the alternatives).
Freakonomics breaks both down pretty well in regards to quitting, whether it be quitting a stock or quitting your book club:
“Sunk cost is about the past — it’s the time or money or sweat equity you’ve put into a job or relationship or a project, and which makes quitting hard. Opportunity cost is about the future. It means that for every hour or dollar you spend on one thing, you’re giving up the opportunity to spend that hour or dollar on something else — something that might make your life better. If only you weren’t so worried about the sunk cost. If only you could … quit.”
In investing, sunk costs often keep us in bad stocks. We are convinced that we have to stand pat in a money-loser, that we have to get back to square in our portfolio … even when a rational look at the stocks at current prices would make us think twice.
That’s why I always recommend looking (or trying to look, anyway) at stocks like you don’t own them. Is Apple (AAPL) a good buy at this price, based on this news, based on these earnings? Forget whether you own it or not — just think in a vacuum.
This helps you mitigate not just the burden of sunk cost, but also the risk of thinking a high-flier will keep running just because it’s a personal favorite of yours and has done right by you.
Similarly, I also recommend comparing every investment vs. its peer group and the S&P 500. Sure, you might be up 10% year-to-date in a stock … but since Jan. 1, that’s actually not all that impressive. Your opportunities elsewhere were better, and that makes your stock a “bad” investment, even if you didn’t lose your shirt.
Or heck, if you “only” lost 20% in 2008, then you could have rested easy knowing you took all the opportunities you had.
I personally focus on opportunity cost a lot in my life, particularly with young children at home and so little time for so many things — and I recommend investors do the same, both personally and in their portfolios.
- Check out the complete feature about the power of quitting. (Freakonomics)
- If you geek out on this stuff, more on sunk cost and investor psychology. (Financial Planning Association)
- The role of opportunity cost in investing. (Investopedia)
Jeff Reeves is the editor of InvestorPlace.com and the author of The Frugal Investor’s Guide to Finding Great Stocks. Write him at firstname.lastname@example.org or follow him on Twitter via @JeffReevesIP. As of this writing, he did not own a position in any of the stocks named here.