If you watched the Master's golf tournament today, you may have seen Phil Mickelson lose the tournament on the 4th hole. He hit a bad shot off the 4th tee that landed in a jungle to the left of the grandstand. At this point, he could have taken a definite loss and returned to the tee. However, he chose not to do this.
I have to ask myself, as one who studies behavioral finance, whether he suffered from both loss aversion and sunken cost fallacy as he decided not to do that.
Loss aversion refers to our tendency to risk more rather than take a sure loss, which is a painful experience. Investors who sell their winners and hang on to their losers are illustrating this point. Returning to the tee meant the penalty stroke and the third shot taken at that point and a clear loss.
In an interview, Mickelson revealed that his strategy was to stay left and that he decided not to take the penalty stroke fbecause he was concerned that, if he re-hit from the tee, he might not be able to keep it left. He wanted to stay left, even if he was in a bamboo jungle and would have to hit it out right-handed. Phil is left-handed. Then, disaster struck.
Mickelson hit a bystander, almost hit himself, and ended up taking two shots to land just out of the bamboo in another bad location.
He then hit another bad shot into the bunker.
So far, we are talking four bad shots to keep to the staying-left strategy.
Is this an example of the sunken cost fallacy? A sunken cost fallacy means that we will not change our strategies because we are already committed to the course of action in which we have invested so much. Investors can do this by "throwing good money after bad" when they cannot correct the original mistake because they have put so much into it.