Last week, New England Patriots fans were greeted with an unprecedented free-agency spending spree by the tight-lipped hoodie in chief. In two days, Bill Belichick spent $243 million on free agents, more than the $172 million his owner spent to buy the team. In the ten years prior, Belichick had spent an average of $36 million per year in free agency. Sports radio ripped and praised the moves. One criticism was that if Belichick had drafted better he wouldn’t need to spend so much now to fix his roster. Great. So what? They had a weak roster. Facing that reality, would Belichick stick with it, or move on? He moved on. In a big way. And in doing so, gave us a master class in avoiding the sunk-cost effect.
One of this blog’s key themes is that you can make money through disciplined investing in stocks and avoiding the traps that keep us from earning our fair share of stock market returns. Those traps are the cognitive biases that interfere with good decision-making. 12 Common Biases That Affect How We Make Everyday Decisions goes into the concept in greater detail.
The sunk-cost effect (aka the sunk-cost fallacy and sunk-cost trap) is one of these biases.
Sunk cost trap refers to a tendency for people to irrationally follow through on an activity that is not meeting their expectations. This is because of the time and/or money they have already invested…Investors fall into the sunk cost trap when they base their decisions on past behaviors and a desire to not lose the time or money they have already invested, instead of cutting their losses and making the decision that would give them the best outcome going forward.Sunk Cost Trap – Investopedia
Sunk Cost Examples
Finishing a bad book or movie, because you’ve already invested the time to get halfway through both and don’t want it to be wasted.
Continuing to throw good money into a bad business or real estate project because of all the money that you have already “sunk” into the project.
Holding on to a stock that has gone down in value even though it’s not the best investment going forward because you are waiting for it to get back to even.
This last one is obviously particularly relevant to this blog. Investors do it all the time. In a rush to lock-in gains, they sell stocks that are up, and at the same time hold onto their losers until they get back to even to avoid losing money. It’s fine to be patient with good investments. In fact, that’s what you should do, but holding on to avoid “taking the loss” gets you in trouble.
Selling your winners and holding onto losers is like cutting the flowers and watering the weeds.Peter Lynch in One Up on Wall Street
The Patriot Way
So, Bill Belichick has a bad roster after a few bad drafts.
He could spend more time and money developing the players that wouldn’t work out. Pay attention to them in practice. Give them reps and playing time. Invest in them with new contracts.
Or, he could cut his losses, admit the team’s deficiencies, face the criticism, and direct his new time and money into a better solution.
We saw what he did. Hopefully, there’s one move left because the quarterback may be the ultimate sunk-cost. But, for now, there’s a lot we can learn from the greatest NFL coach of all time about not throwing good money after bad.
Suggested Further Reading
Investment Mistakes to Avoid – learn about other ways to protect your portfolio from yourself