How the Sunk Cost Fallacy Affects Your Life
In the next few lines you’re going to be asked to make some choices. Be honest: How would you decide?
1. You’re in the cinema. Unfortunately, the movie turns out to be boring and you know you won’t enjoy it. What do you do:
A: Leave and use the time for something else.
B: Stay and watch the movie till the end because you paid for the ticket.
2. You’re in a café eating ice cream. You’re feeling quite full already and have no need to eat more. Do you…
A: Stop eating.
B: Finish the whole ice cream because you will have to pay for it anyway.
3. You have been working on a project for several weeks and invested a lot of your time into it. Still the results are way below your expectations and there is no guarantee the project will become profitable in the future.
A: You decide to cancel the project immediately.
B: You keep on working in the hope that tides will turn.
In how many of these situations would you choose (or have chosen in the past) option B? In all 3 cases, option A would be the rational thing to do. However, many people tend to go for option B, leading to them losing time and money. The reason for this is a cognitive bias: The mistake of letting sunk costs affect your decision-making process.
What are sunk costs? Sunk costs are expenses from the past that cannot be reverted by decisions in the present or future. No matter what you do next, the invested money is gone and can’t be retrieved. Therefore, these costs should be irrelevant to your decision-making.
Sunk costs are not the same as fixed costs. Let’s say a company buys a new machine to produce more units. The sunk costs are the initial expenses for the purchase of the machine. The fixed costs are the ones arising by running the machine every month, regardless of the number of units produced. The fixed costs are the same each month, however, you can avoid them by not running the machine at all. Here lies the difference between fixed and sunk: The sunk costs cannot be influenced anymore. It doesn’t matter if you run the machine or not: You already paid for it anyway. Sure, you can try to sell the machine again. But it’s unlikely you can sell it for the original purchase price. At least a big chunk of the original cost of buying the machine is sunken forever.
Sunk cost fallacy means that you pay too much attention to the sunk costs in a situation where it would be better to ignore them. Because sunk costs are irreversibly lost they should not be taken into consideration when making a decision. What matters is the future and the present situation. Is it reasonable to keep on spending money, time, resources? The answer to this question should determine what you do. The last thing you should do is using past expenses as an argument for investing more. Often, people argument for prolonging a project by saying: “If we stop now, everything we invested so far is lost,” not realizing that everything they invested is lost anyway and has zero impact on the future. This is the reason why the bias is also known by the term “throwing good money after bad”.
A prominent example of the sunk cost fallacy gave the bias its other name “Concorde effect”. In 1962, the British and French government started a project to build a supersonic airplane. Before the plane was finished it became clear the project would not be profitable due to the immense costs. But even though they were fully aware of this issue, the two involved governments kept on pouring money into it and refused to exit the project. Their decision was influenced by their national pride and the biased argumentation that all invested money would be lost if they cancelled the project.
Defeating the sunk cost fallacy requires those involved to think clearly and rationally. Sunk costs are always lost, no matter what you decide, but you can choose to stop before it’s too late or continue spending and lose even more. I believe there are two important things to keep in mind to avoid the traps of the sunk cost fallacy:
1. Don’t let your pride take over your decision-making. Nobody likes admitting mistakes but keeping a project alive that is doomed to fail won’t save your ego from taking a hit. You’re just delaying it.
2. Accept what’s lost and move on. Your money is gone the moment you spend it. No matter if you watch the movie till the end or not, you don’t get your money back. Therefore, ignore the sunk costs and base your decision only on your assessment of the present and the future.
When I asked a variety of people how they would answer the questions are the start of this article many of them chose option B. Interestingly, some people say they would still choose option B after being told that option A is the more rational decision. Somehow, people feel like they don’t lose the invested time, money or effort if they just keep on and finish what they started.
Even though it’s irrational to behave like this, it might sometimes make sense to do so. In a situation like the one in the cinema, leaving after 20 minutes would save you time. But how much is that time worth if the decision puts you in a bad mood because you feel like you just lost your money? Compare the value of the resources you would lose with the negative emotional impact the decision can have on you. Leaving the cinema is the rational thing to do but I would not recommend you doing so if it will leave you full of regret. What matters are the potential consequences of the decision. If people’s jobs or large amounts of money are at stake, you cannot afford to irrational. However, if it’s about spending an hour longer in the cinema you don’t need to force yourself into making the most rational decision. Sometimes, acting irrational just feels better.
