The Sunk Cost Fallacy: Understanding Sunk Costs
Picture the scene: it’s a Wednesday night, it’s raining outside and you feel like you’re coming down with a cold.
Picture the scene: it’s a Wednesday night, it’s raining outside and you feel like you’re coming down with a cold. However, you’ve spent money on tickets to see a band you’ve wanted to see for a while – what do you do?
You could swerve the gig. It’s probably best if you stay in anyway, so you can feel better over the next few days. Plus, the weather is looking bleak as it is. So why can’t you ignore that annoying voice in your head telling you to go?
You find yourself lugging your way out of bed, away from the TV and on your way to an event that you don’t really want to go to, afraid to throw good money away. Even though you paid for the tickets ages ago, and the money is no longer going to be a factor, you put on a brave face and try to “enjoy” the band regardless.
This is what’s known as the sunk cost fallacy.
Sunk cost fallacy definition
The sunk cost fallacy is a curious aspect of behavioral decision making, the act of continuing to pursue an outcome based solely on a previous investment rather than using more rational decisions. This investment could be time, money or effort, although the most common tend to be monetary, as this is more directly accountable. Natural human decision processes make it hard to ignore sunk costs
When we concede to sunk costs we focus on the input rather than the output. Despite making the initial investment to achieve a bigger gain, when variables change we set aside this clarity and hold our nerve based solely on the initial investment made as a form of perceived loss aversion.
Whether we are aware of it or not, the cost has already “sunk” meaning that the outcome of your investment is no longer dependent on it. By focusing on what we have put in when it’s already gone, rather than what we get out, we can become blind-sided and risk not achieving a positive outcome at all. And the desire to avoid negative emotions related to sunk costs doesn’t just affect the decision making process of individuals. We see this kind of thinking on a larger scale as well; it is evident in national economic behavior, in decisions by companies to remain committed to outdated products or strategies, and even entire societies fall victim to irrational decisions.
Examples of the sunk cost effect
The new invention of cryptocurrency has made it easier than ever for the general public to make investments without even knowing what they are buying. Say you invest $500 in the hope that it will double, you may find that it is tempting to hold out even if your investment begins to tumble. You may then be further in than you can afford, but you still believe that you cannot withdraw your money.
A similar example is when companies continue to buy new pieces of equipment, machinery or put money into advertising campaigns. Those that study organizational behavior see that, typically, there are bigger investments at stake, investors to please and potential profits to be made. But this can still make it difficult for corporations to back out of these when the predicted outcomes change and a focus may shift to “make it work”.
It’s not always about money
Sunk costs do not always have to be monetary either, they can also relate to other factors such as time and effort. For instance, some people may stay in a relationship for years purely because of the significant amount of time they have spent with each other. If two people are not right for each other, then it is easy to succumb to the sunk cost as a reason to stay together.
The same applies to the likes of education or careers. Continuing on a course or in a job that you no longer enjoy or see a future in can be an easy trap to fall into the further you pursue it. The amount of physical, mental and emotional effort invested in a venture like a university degree or starting a new career is huge and this is magnified at a younger age where experience and money are typically harder to come by.
Why do we fall for the sunk cost fallacy?
In a word: emotion. You may have heard hard-nosed business folk say “leave your emotions at the door” when speaking about investments and this applies to the sunk cost fallacy. As humans we are conditioned to assess risk in order to survive, however as part of this we can end up attaching ourselves to these same risk factors even once they have passed.
When we spend significant time, money and effort on something we are emotionally invested as we know that this has an impact on our future. Despite the fact we may end up with a positive outcome, it is difficult to get past the potential negative effect. It is this weight on our mind that prevents us from remembering why we made that investment in the first place.
How do you avoid sunk costs?
To gain the best outcome for our investments, the most important thing is to recognise the signs of potential sunk costs. It’s likely that the majority of us have at least one example of a sunk cost in our lives, so here are a few tips to help you minimise your exposure:
Without realising, you may attach yourself emotionally to investments that you make or are responsible for. As a result you could find yourself blindsided to try and prove a point to ourselves or others. This can ultimately distract us from the original purpose of the investment.
To avoid this it’s crucial to gather feedback from others to help you. Not one person can know everything, so seek advice from a third party to help validate or correct a decision before you make an investment. Make sure to remain objective when requesting and receiving feedback as any further emotion could cloud your judgement. In a professional setting it may help to do this anonymously, whereas in a more personal investment it may be better to do this in private to avoid any external bias.
Better still, data is your best friend. Even your most trusted circle may not be able to give you the best advice possible, so dig into the details and use this to spot the signs of when to get in or out. This could be analysing market trends or even just calculating your monthly outgoings – either way the numbers can’t lie.
Cultivating new habits
If you find yourself regularly regretting going to events or throwing good money away you could be falling into the sunk-cost fallacy. To make changes, first recognise what these habits are and identify the patterns. Most importantly at this moment make sure to not fall for the fallacy once again!
Through this process of introspection it can be daunting to acknowledge and appreciate our problem. You may find yourself saying “that’s just who I am” or “I won’t ever be able to change”, but this is by virtue the root of the problem. Everyone is capable of bettering themselves, so don’t let old habits die hard.
Once you have identified these patterns the causes and solutions will become much clearer. These may not always be the easiest to action, you may have to cut down your spending or perhaps be a bit more assertive in a relationship, but by tackling this head on you can achieve a better outcome.
Make sure to reflect on past situations where things have panned out differently and use these as reference points. Each time that you make these new actions you are taking a step closer to becoming the best version of yourself, so remind yourself of the hard work that you have done to stop yourself becoming overwhelmed.
It’s not always possible to avoid the sunk cost fallacy, so it’s important to at least fail fast. Failing may seem like a negative term, but really it should be a synonym for trying. Without taking risks in life we are unable to learn and grow as humans, however it’s better to fail, learn and move on quickly if you are going to take a risk.
This is especially important for businesses and entrepreneurs when accounting for costs or proving new concepts. It can feel tempting to “make it work” when you have made an investment but make sure to recognise when a cost is sunk. Balance the output vs the input and make a rational decision on your next steps. Better still, cover your down-side before making the initial investment so that you have something to fall back on if the original plan doesn’t go through. This could be a case of having a contingency budget or taking out insurance in order to help alleviate some of the impact.
Learn, adapt, improve and do it quickly. The most successful people in the world are able to look inwardly at themselves and have the integrity to know when they have made a mistake. This helps them stay ahead of themselves and even their competition.
Dealing with sunk costs and future costs
Hindsight may be a wonderful thing, but it isn’t always possible to avoid sunk costs. Through the sunk cost fallacy, you may find yourself emotionally absorbed with past decisions and that can take a real toll on your mental and physical health.
It happens to everyone
Firstly, remember that even the best businesspeople, governments, celebrities and likely a lot of your own friends and family have fallen into the sunk cost fallacy at least once in their lives, so you are not alone. Remind yourself that however seemingly impossible it may seem to get out of a sunk cost, acceptance is the first step towards growth.
From here it is key to think practically. Ask yourself what are the immediate factors that I can control or influence? Who can I ask for help in this situation? What are the steps that I need to take to get to a positive outcome?
Ensure that you keep momentum by taking a breath before you act. Even a minor pause and internal countdown can help process your actions and make them more effective. Meditation can help with this by focusing the mind and enabling self-awareness.
At each step in your journey acknowledge how far you have come and remind yourself of why you are doing something rather than how you are going to do it. Dust yourself off and give yourself gratitude for taking positive action, and when it gets too much practice some stress relief techniques such as exercising, journaling and even just putting down your phone for a while.
Selflessness vs selfishness
For anyone who describes themselves as an empath, saying no can be a terrifying prospect. Unfortunately, this can also be a big cause for sunk costs. You may have spent years agreeing to plans, opinions and investments to pacify others, but this can become overbearing and distract you from achieving what you set out to.
In this scenario it’s important to separate selfishness from selfless behaviour. Despite good intentions, not saying no may actually be more selfish than it is selfless. Let’s say that a friend invites you to a dinner party that you know you aren’t able to attend. You accept the invitation and go to the dinner, having to sacrifice your other plans. You may feel resentment towards your friend for ruining your plans and tell yourself you were “just trying to make them happy”, when in reality it would have been better for all parties involved to say no to the invitation.
Be clear with your intentions from the output and this will make it easier to say no. There is always the potential for it to feel awkward and to upset others in the process, however continuing old habits to appease others will only cause more damage in the long run. Make sure to acknowledge and reference previous experiences of when this has worked as this will enable you to deliver the news in the correct manner.
Opportunity is a wonderful and exciting thing. It’s why we buy lottery tickets, go on new adventures and commit ourselves to others.
However, no one teaches you to stop giving when you don’t need to anymore. Unless you were born an accountant, economist or risk-analyst you’re probably less likely to know how to listen to the rational voice in your head.
It’s perfectly fine to make mistakes, if anything it’s a fantastic quality about us as humans. But to truly unlock the best qualities in ourselves we need to acknowledge these mistakes and make the tough decisions to go down the new track.