The Good Chasing the Bad

The same phenomenon happens in investing too. Say you are wealthy and invested a billion dollars into a biotechnology company called LOSR. After many years, they are running out of money but have yet to reach any conclusive findings. They tell you they are very close, and just need another $400 million to make that major breakthrough.

Now if you had just become knowledgeable about this company, you might conclude that based on the traction you have seen, the executive team is completely incompetent and you wouldn’t even invest $20 in them. Why throw money down the drain?

As in the poker example, our inability to cope with sunk costs pushes us to take irrational actions – putting in good money to chase after bad money. You end up reluctantly putting the extra $400 million into LOSR in order to save the $1 billion you’ve already sunk into it.

Sure, there might be a slim chance that the company does end up making a major breakthrough, in...