Ed Mamula.com

As if any more evidence were needed to prove that I am a financial nerd, I have to confess that I got an economics degree for fun.  That’s right, and I have no shortage of friends who tell me how boring Economics 101 was.  In fact, the presumptions about human rationality that are built into basic economic theory are enough to make a lot of people dismiss all of economics as nonsense.

However, there are some basic concepts from Economics 101 that are wonderfully useful in everyday life, and seem to be horribly under-utilzed.

Today’s concept is that of Sunk Costs –  Sunk costs are costs that have already occurred and cannot be recovered.  Economic theory tells us that rational people do not consider sunk costs when making a decison about what to do next.  The rational thing to do is to consider what the best decison to make today is, taking the sunk costs as given.

This has many applications in real life, and I have to admit, I almost never see anyone properly put sunk costs out of their mind, when indeed it would be beneficial for them to do so.

Improper and common ways that “irrational” (normal) people consider sunk costs:

•  Staying in an unsatisfying relationship because of the “history” the couple has shared.
•  Spending more money on a bad project because money has previously been spent on it. I see this one in software development all the time.
•  Making dangerously large bets or trades in an attempt to “get back to even”.
• Averaging down on a trade – another countertrend trading concept that is really just a fluffy way of saying throwing good money after bad.
•  ”Letting yourself go” — not caring about gaining weight because you are already overweight.

These are all scenarios where we can benefit from taking a step back and observing the situation in a detached and logical way.  Accept that life has brought you to this present moment with a set of circumstances or baggage which is a given, and cannot be changed.  All you can do is make the best decision to improve yourself or your situation going forward.  It does you no good to complain about the cards that life has dealt you.  You must play your hand to the best of your ability.

In Economics 101, we’re presented with the simplifying assumption that people behave rationally.  This assumption, along with other equally unrealistic assumptions such as perfect information, allow us to build cute models to explain the behavior of markets.  As if there were any need for more proof that people do NOT behave rationally,  I offer this: My automated Forex system, the Cable Glider, placed a trade in the last 24 hours that netted me a gain of $1,860.  This put the system at a 6.2% positive return for February, and put me at a new all time equity high.  This makes me happy.

The Carnival of Investing - Super Bowl Edition was published today and included a link to EdMamula.com…this link drove some traffic to this my site and resulted in $1.26 worth of ad revenue.  That made me HAPPIER.  I’m sure we all have experienced similar things.  It’s a bit like driving that extra mile to save 2 cents per gallon on gasoline.  Of course, ask anyone who has taken Economics 101, and they will tell you that yesterday’s winning trade should make me 1476 clicks happy…somehow, the emotional mathematics just don’t work that way.   AND, for fun, I’ll go ahead and donate that $1.26 to the Hunger Task Force…let the economists figure THAT one out.