One day in the late nineteenth century, the steel magnate Andrew Carnegie was being toured around his company’s newest plant by his chief operating officer, Charles M. Schwab. Even as Schwab extolled the plant’s modernity, Carnegie sensed a hesitancy that wasn’t characteristic of his normally ebullient lieutenant, and inquired as to its source. Schwab admitted that there had been significant technological advances since they had started building the plant, and expressed the wish that they’d built it even six months later, so as to capture the new cost-saving capabilities. Carnegie asked how much that would have lowered the cost of production, and Schwab said, “At least four dollars a ton.” Carnegie instantly said, “Tear it down, Charlie, and build it again as it should be.”Andrew Carnegie’s genius (like John Rockefeller’s in oil) was to know that the low-cost producer of any commodity will dominate the market. He knew that if he ran his new but imperfect plant, someone would sooner than later undercut his price, such that instead of recovering the cost of the plant, he’d end up throwing good money after bad by having to run it at a loss.

Welcome to the essential economic concept of sunk costs: the idea that, regardless of what you paid for it, the only real value an asset has is what it will sell for today, or what it will earn (and thus sell for) in the future. The past, you see, is irrelevant to today’s and tomorrow’s value, and your cost, at some point in the past, is the ultimate irrelevancy.

If your parents bought a particularly happy Renoir from some ruined French aristocrat in 1946 for $50,000, and you sold it to the Japanese in 1989 for $80 million, that’s one kind of experience. If you, on the other hand, were the $80 million buyer in 1989, and recently found that the painting couldn’t be sold for more than $60 million, that’s a different kind of experience. But the painting is still the same ineffable, luminous and inexpressibly beautiful work of art it’s always been.

These analogies, though imperfect, may at least suggest a vitally important truth, and one which will become even more important as the equity market continues its recovery toward its levels of a year—and then two years—ago. To wit, your investments do not know what you paid for them, and would not behave any differently if they did. Making investment decisions based even partially on your own (sunk) costs all but insures that you’re going to make mistakes; the only real question is how big the mistakes are going to be.

Near the depths of The Great Panic earlier this year, a friend in his late 40s mentioned to me that he was thinking of moving from a balanced mutual fund (one that contains both stocks and bonds) to an all-equity fund, for its greater appreciation potential over the balance of his working lifetime. I agreed with his reasoning, as who could not. He then asked, “So do I wait until I get even on the balanced fund, and then switch?”

I said, “Tell me again why you would want to do the switch in the first place.” He said again, “Because an all-equity fund has more long-term growth potential than a fund with a significant percentage of its assets in bonds.” Then while you are waiting for your balanced fund to “break even,” I asked, what will probably have happened to the all-equity fund you want to own? After a long silence, he said, “It will probably have gone up even more.”

However anecdotally, this true fable suggests the power of one’s own cost basis to short-circuit rational thought. In this instance, if the thing my buddy wanted to own really had more potential than the thing he wanted to sell—and of course it did—he would in all probability have lost some incremental return by waiting for his balanced fund to return to the price he paid for it. As soon as he stopped focusing on his cost, and started focusing on what he was trying to accomplish (more long-term appreciation for retirement), he saw that.

The reason this issue will become more pressing as the equity market continues its recovery is the intensely human impulse—driven entirely by a morbid obsession with one’s cost—to “get even and get out.” This is, in effect, the act of punishing yourself for the heroic act of hanging on throughout a bitter decline. Once the market (and/or your investments) come all the way back, and emerge into the bright sunshine of new high ground, you cut yourself off from all the marvelous wealth-building opportunities that an expanding economy, restored to health and vitality as it has always cyclically been, has to offer. This has all the elements of tragedy.

Investing, for most of us, is fraught with more than enough emotional peril. Try not to bring any extraneous emotional baggage to the process. Your cost, as intensely personal as it may feel to you, is no factor in what your investments—on their own merits, and compared to other available investments—will do today, next year, and over the balance of your investing lifetime. Try, to the greatest extent possible (and always with your financial advisor’s wise coaching), to think as if the current market price is identical to your cost.

Then simply ask, “Is this the portfolio I would buy today, if I were holding nothing but cash, and if today were the first day of the rest of my investing lifetime?” However you answer that question, the resulting outcome will almost have to be clearer, more rational and more productive than any decisions you make under the cloud of regret that always hangs over an obsession with your cost.

© 2009 Nick Murray. All rights reserved. Used with permission.