The Investment Scientist

Posts Tagged ‘sunk cost

Sunk-shipMany people keep their bad annuity investment because it imposes a stiff surrender charge. This is a stereotypical example of sunk cost fallacy, an academic term which describes people throwing good money after bad.

Why surrender charges are sunk costs?

Imagine you were sold a $100k variable annuity with a ten year surrender period. The agent who sold you the contract collected a 10% commission, or $10,000. Where do you think this money came from?

Bingo! Your pocket. I hate to break it to you, but insurance companies are not in the charity business and they sure as heck aren’t gonna tell you that 10 of the 100Gs you just handed over to them are going to pay the agent’s commission! If they did that you’d pull your money out and rightly avoid them like the plague in the future.

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Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.

Twitter: @mzhuang

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