The Sunk Cost Fallacy and How to Beat It

We all see the sunk cost fallacy in action during our day to day lives.

Sunk Cost Fallacy Illustrated

It is a warm summer day. You are meeting your friends for baseball. On the ride over you realize you don’t want to go but you already bought the ticket so you might as well go. It starts well. Tailgating was filled with a cold beer, cornhole, and trash-talking about the teams. Your friends and you start shuffling into the stadium to find the seats, just along the third baseline.

The game is a little delayed because the national anthem went on too long and the announcer was over-indulgent in announcing the lineups. By the first pitch, you are sweating a little but still having fun. Conversation with friends and the people in the area is fun and light. However, after an hour it’s only the third inning, you are hot, the conversation has lulled, and the game hasn’t had any action. You want to leave, but will you? The rational idea would be to leave and go do something else with your time.

However, because of the sunk cost fallacy, you will stay at the baseball game. You already spent money on the ticket. This means, that you are accepting the waste of money on the ticket price and watching the remainder of the game without enjoyment.

Doesn’t sound very fun, does it? This is what sunk cost can do.

What is the Sunk Cost Fallacy?

In economics, a sunk cost is a cost that has already been incurred and cannot be recovered. Sunk costs should not be relevant to decisions in the future because they have already been incurred.

However, sunk costs do factor in everyday day decision-making, even though they shouldn’t.

The Reason for Sunk Costs

Daniel Kahneman is a noble prize-winning behavioral economist who has studied the extensive effects of the sunk cost fallacy. The main reasons for conforming to this fallacy are below.

1. Loss aversion: People tend to prefer avoiding losses to acquiring equivalent gains. In other words, it is better to not lose $5 than it is to gain $5. Because of loss aversion, the price paid in the sunk cost becomes the benchmark for the value, whereas the price paid should be irrelevant in decision making. In the above case, it is better to not lose the price of the ticket, than it is to leave early and gain the time back because the perceived lost price of the ticket outweighs the perceived benefit of the time.
2. Framing effects: this is the tendency for people to avoid risk when a positive frame is presented but seek risks when a negative frame is presented. So in this example, “gain two hours to go do something else” is not as strong as the frame of, “leaving the game early with two hours left.”
3. The overoptimistic probability bias: this is where the investment is already incurred, yet there are now more optimistic predictions on the future of the game. Since you have already invested money in the game, you are likely to think the game will pick up in the later innings. However, if you stayed at home and were watching the game with no money invested, you would change the channel to something more exciting.
4. Perceived personal responsibility: since you bought the ticket and made the decision to go to the game, you are personally responsible for seeing the game through. That sense of personal responsibility will keep the decision more salient.
5. The desire not to appear wasteful: by leaving early, it would be an admission that money spent is not worth the time. Which appears wasteful, especially if it was an expensive ticket.

Why does the sunk cost fallacy matter?

Opportunity cost can influence more than the benign decision to stay two extra hours longer at a Baseball game. The sunk cost can be prevalent in investing, careers, and even relationships.

Investing:

People get more optimistic in their return-on-investment once they put their money into something. To illustrate this, Knox and Inkster approached horse bettors to see how they felt their horses would perform. Horse racing is not a sound investing strategy, but it illustrates the point. People who were about to place bets rated their horse as having “a fair chance at winning”, while people who just finished betting gave their horse “a good chance of winning” and a whole 1.5 more points on a seven-point scale. After just a $2 commitment, people felt more confident their bet would pay-off. In investing, this explains why people will invest in a stock after it shows signs of tanking in the market. They are confident their investment will turn around because they already put money into it in the first place. Trying to stay consistent explains the mantra of, “throwing good money after bad”. The money is spent and shouldn’t factor into the decision, but it does anyway.

Relationships

The same can happen in relationships. Paired with personal responsibility, time, energy, money, personal history, and emotions, sunk cost explains why sometimes people stay in relationships that are not going anywhere or are toxic for too long. There are other factors, and one of them is all the time already spent. Studies show people find it difficult to admit that time was wasted as it gives a public omission that dating this person was the wrong decision. It can cause pain in more ways than one, so people would rather suffer silently in this past decision, then ends things to move onto something better.

See tips on how to have a long-lasting relationship here!

Careers

Sunk cost also explains why people stay in careers they don’t find fulfilling anymore. Studies show this happens as early as college. Where people go into a field that doesn’t interest them because that is what their degree is in. Letting a decision that took four years and tens of thousands of dollars dictate their forty-year career that generates a couple of million dollars.

Learn how to find your dream career with this post!

Photo by Nastya Dulhiier on Unsplash

How to overcome the sunk cost fallacy

Studies show several ways to overcome the sunk cost fallacy.

1. Mentality Realize the past cost cannot be recovered. Money, time, and energy are already spent. They cannot be recovered
2. Accept the best time was twenty years ago, but the second-best time is today.
3. Do not view the time as time wasted: see it as growth. Seeing sunk cost as growth reframes the time in a positive light. Even if it was time spent doing something that now you don’t want to do, it is better to see that view as now you know you don’t want to
4. Visualize the future. What would the future you thank you for doing?
5. Focus on the bigger picture: practice WOOP to see what you want out of life. Focus on the big picture first to see that your decisions should align to pursuing these goals instead of whatever the present moment entails.
6. See the gap. Use WOOP to see the obstacles and roadblocks blocking the current path to what you want. See what you would rather have and work towards that.
7. Acknowledge as we grow older, our interests and passions change. Let your goals evolve with your interests.

Main Take-Aways

• The sunk cost fallacy can affect every area of your life from financial decisions, careers, and relationships.
• Recognize when the sunk cost fallacy is happening to you and implement one of the strategies to overcome the effect.

Action Item

Reflect on a sunk cost you experienced sometime this week. What do you wish you did differently? How can you use this experience to take lessons for your future self?