What is sunk cost fallacy and how does it impact our decision making
The sunk cost fallacy is a cognitive bias that impacts our decision making. It happens when we let the sunk costs of an action affect our judgement about whether or not to continue on with it. We feel like we need to finish what we started, even though it's no longer worth it, because of all the time and money already invested into it. This can be seen in business decisions as well as everyday life situations such as continuing on with classes at school after realizing they're not for you anymore.
The sunk cost fallacy is believed to have roots in evolution, where animals would continue hunting for food even if they were starving, simply because they had put so much time and energy into the search already. This same behavior translates to human beings today--we often invest more effort (time, money) into something just because we've invested so much before. The truth behind this theory is that investing more will not necessarily yield better results; however, the idea of "waste not, want not" does have some merit.
The biggest problem with the sunk cost fallacy is that it can lead to faulty decision making and a waste of time and money if we let it get in our way. For example:
- Committing to pursue a relationship even when there are clear signs that things aren't going well because you already invested so much time
- Paying for a service that you don't like because you've paid for it, even though there are other similar services available at your disposal.
How sunk costs affect our judgement
The sunk cost fallacy can be harmful in many different situations. When you are presented with the option to continue on a project, task or relationship that is not working out for you due to continued loss of resources (time, money, energy), it may seem like common sense to keep investing into it, hoping you can eventually turn things around. The pain of walking away seems worse than the pain of staying the course.
This decision making process can be seen all around us in our daily lives, whether someone decides to stick it out with a job they hate because of their years of investment or stay in an unhealthy relationship longer than necessary due to the time and effort already put into the relationship. However, there is a cost to continuing investment in these scenarios and it's important that we keep this fallacy in mind when making decisions about our time and resources.
Sunk costs should not affect our judgement. Our future decisions should be based on present circumstances.
Why it happens
As human beings, we are not always rational in our decisions and are often influenced by our emotions. If we have previously invested in a decision, we are likely to feel guilty or regret not following through. The sunk cost fallacy is linked to the commitment bias, where we stick to our guns even when new evidence suggests otherwise.
We fail to consider that any time, effort, or money spent will not be recouped. As a result, we make decisions based on past costs rather than on current and future costs and benefits.
The sunk cost fallacy is caused by loss aversion, which is the perception that losses are worse than gains. We avoid losses rather than seek gains. We may fear losing our previous investment if we don't follow through, so we make decisions based on loss aversion rather than considering the benefits gained if we don't.
Making a decision and not following through is one of the reasons why it feels like a loss. If we don't follow through on a decision, we've failed, even if the decision not to commit was in our best interest. Even if the costs are higher, such as going to the concert despite the rain and a cold, the story can be framed as a success. The story would be that we wasted $50, not that we made a wise choice for our health.
Why it matters
As shown by the examples in this article, the sunk cost fallacy affects many aspects of our daily lives as well as major decisions. The sunk cost fallacy leads to irrational decisions and sub-optimal outcomes. We focus on past investments rather than current and future costs and benefits, resulting in decisions that are no longer in our best interests.
How to avoid it
Even though it's difficult to overcome inherent cognitive fallacies, we can try to focus on current and future costs and benefits instead of past commitments. The sunk cost fallacy can be reduced by focusing on concrete actions rather than the wastefulness or guilt that comes with breaking an earlier commitment.
But we can't ignore our emotions because they shape our decisions. Instead, we can use technology to assist us. IT systems make rational decisions unaffected by the previous decisions.
Examples of sunk cost fallacy in action
Jane and John were at their wit's end. They had to make a decision: either they could go through the rain to make the show, or they could stay home and enjoy a cozy night of Netflix.
"What on earth made me think it would be a good idea to buy tickets for this?" John grumbled as he stared at his phone, the weather forecast predicting rain all day. Jane shrugged and put her earbuds back in. "I can't believe we paid $60 for these tickets."
"What the heck," John muttered, looking up at the darkening sky. "We can't let a little rain get in our way." He reached for Jane's hand and tugged her across the street. "It's not like we're going to melt!"
Jane shook him off with a laugh. "I don't know, I'm feeling less enthusiastic about this." She gestured to their wet clothes and shoes that had already filled with water from walking through puddles on the sidewalk. It was no use--John looked stubbornly determined to make it all of three blocks before they turned around and called it quits while they still could--so she sighed and continued on, putting one foot in front of the other.
Trudging through the rain to see a show we bought tickets for, but don't really need to see anymore, is a great example of sunk cost thinking. Even when we'd rather be wrapped up in bed sipping hot chocolate and watching Netflix, something in our heads makes us think we've wasted the money if we don't go through with our original plan.
In a different situation, if we're going out with friends and one of them is in a particularly bad mood or negative state that night, it might be better to leave the friend at home because continuing on with the outing when they clearly don't want to go will likely make everyone less happy. When you take away sunk costs from these situations, you can make better judgement calls.
These are just a few examples of how sunk costs affect our judgement in everyday life situations, but the truth is that this fallacy presents itself in many different ways on a regular basis. It's important to keep your mind open when making decisions about time and money so you don't fall into its trap!
4. Tips to avoid the sunk cost fallacy when making decisions
When making decisions about sunk costs, it's important to remember these 3 tips:
- only focus on sunk costs that still impact future outcomes;
- don't let sunk costs affect current decisions; and
- always think about how sunk costs can be avoided in the future.
As another example, if you buy new shoes but they start hurting your feet, it may be easy to think you need to keep them. After all, you’ve already spent the money to get them. And perhaps the return date has passed. But is it logical to continue wearing shoes that hurt your feet just because of the sunk cost? Here’s a great mental exercise:
If a stranger came up to you and offered you shoes that hurt your feet, would you accept them? Probably not. So if you wouldn’t accept this gift from a stranger why would you accept the gift from your past self? Your present self knows better. The shoes hurt. You shouldn’t wear them.
You can't change what you've already spent, but your past self's decisions don’t have to become your present or future self's mistakes. Remember that sunk costs are just gifts from our past selves — they don't define who we are as people, so we should never let them determine our actions.
The sunk cost fallacy is a cognitive bias that can easily impact our decision making. It's important to remember sunk costs are irrelevant when evaluating the worthiness of an investment, and it takes discipline not to be affected by sunk costs in your judgement. The tips provided should help you avoid this logical fallacy so you can make sound decisions in your life. If all of this seems overwhelming or if you want to join a supportive community of intellectually curious folk, subscribe!
Which sunk costs have you avoided recently? Let us know in the comments.