By DAVID MOON, Moon Capital Management
A News Sentinel headline last week declared that
the city of Knoxville could lose $5.2 million on a planned land sale to Sysco
Corp. so the company can build a distribution facility. Ignoring the economic
benefits of the 300 new jobs Sysco will bring to the area, the headline was
misleading for another important reason: the city will not lose $5.2 million by
selling the property to Sysco, even though the selling price is $5.2 million
less than the city's $7.4 million investment in the property.
The city's cost to purchase the land and cap the
contamination on the site is a sunk cost and is irrelevant to any potential
buyer of the property. The city has already lost that money, even though the
loss is realized only when the sale is complete.
Historic sunk costs are logically irrelevant in
determining what actions to take in the present. The old Coster Shop property
has a limited number of potential users and uses. The amount of money the city
spent to acquire and prepare the property is irrelevant to the potential market
for the property.
The notion of sunk costs doesn't just foul up real estate
investors and newspaper headline writers. Stock investors succumb to it all the
If you buy a stock and the price falls from $30 to $20,
don't let your initial purchase price affect whether or not you sell the stock.
(This, and the other examples I use, ignore capital gains taxes. Taxes
complicate the issue and may change your decision, but they don't change the
concept.) The stock has no idea what price you paid for it.
It is irrelevant that you paid $30 for it. All that is
important is whether or not you would be willing to pay $20 for it today,
assuming you didn't own it.
It is common for folks to argue that they haven't lost
anything until they sell it. Wrong. You lost the $10 when the stock declined.
You just didn't create a taxable event by selling the
But you say you don't want to sell the stock (or
inner-city development site) until it gets back to what you paid for it.
The best way to earn your money back may not be the same
way you lost it. It is possible that the price may never get back to your
What would you do today, ignoring what you have invested
in the stock to date?
I'm not suggesting that you should be biased in favor of
quickly (or slowly) selling your losing stocks. The point is that your position
of profit or loss is irrelevant to the relationship between the current price of
the asset and its value.
Have you ever heard the real estate adage that you make
your profit on a real estate transaction when you buy the property, not when you
sell it? Despite what the taxman sayeth, the same is true for losing money.
David Moon is president of Moon Capital Management, a
Knoxville-based investment management firm. This article
originally appeared in the News Sentinel (Knoxville, TN).