It’s Not the House’s Money

Welcome to MutualFunds.com. Please help us personalize your experience.

Select the one that best describes you

Your personalized experience is almost ready.

Join other Individual Investors receiving FREE personalized market updates and research. Join other Institutional Investors receiving FREE personalized market updates and research. Join other Financial Advisors receiving FREE personalized market updates and research.

Thank you!

Check your email and confirm your subscription to complete your personalized experience.

Thank you for your submission, we hope you enjoy your experience

Burning money in hand

News

It’s Not the House’s Money

Larry Swedroe Aug 11, 2015


After pointing out that his original investment had grown to a fairly significant percentage of his overall portfolio, I suggested that he sell at least some of the company’s stock and diversify his holdings. His response was: “What could go wrong? I only paid $20 for it.”

This line of thinking is caused by a common mental accounting mistake, one I call the belief that you’re playing with what’s known as the “house’s money.” It is also one of the surest ways I know to turn a sizable fortune into a small one. To help the investor in question consider the issue in the proper context, I related the following tale…


The Legend of the Man in the Green Bathrobe


And so it went, until the lucky groom was about to wager $7.5 million. The floor manager intervened, claiming that the casino didn’t have the money to pay should 17 hit again. Still clad in his bathrobe, the young man taxied to a better-financed casino. Once again, he bet it all on 17, only to lose everything when the ball fell on 18.

Broke and dejected, the groom walked back to his own hotel room. “Where were you?” asked his bride. “Playing roulette,” he responded. “How did you do?” she queried. His reply: “Not bad. I lost $5.”


Undervaluing Hard-Earned Money


It’s likely that if our groom had earned the money the hard way, he never would have made such a bet. On the other hand, it’s easy come, easy go. Mental accounting, in this case, allowed the man in the green bathrobe to think of the $7.5 million he had just lost as the “house’s money.” Investors make this same mistake.


Knowing When To Cash Out


When I asked my friend if he would buy more of the stock at its current price, he said, “No.” I explained that if he wouldn’t buy any, he must believe that it was either too highly valued or he was currently holding too much of the stock, and it was too risky to have that many of his eggs in one basket.

Despite the logic, my friend steadfastly refused to sell some of his shares for the following reason: His cost was only $5, and the stock would have to plummet about 95 percent before he would post a loss. I then asked him if he owned a green bathrobe.

A year later, Cisco was trading at about $16 and my friend was still holding it. Mental accounting had caused him to make the same mistake as our groom. He had considered his unrealized gain to be the “house’s money.”


The Bottom Line


And if you don’t have a plan that includes such tolerance ranges, you should take the time to develop one. Doing so, and then adhering to it, will prevent you from making many of the behavioral errors I discuss in my book, Investment Mistakes Even Smart Investors Make and How to Avoid Them.


Sign up for Advisor Access

Receive email updates about best performers, news, CE accredited webcasts and more.

Please Enter Your Email
Please Select Your Advisor Type

Popular Articles

Download Our Free Report

Why 30 trillion is invested in mutual funds book