The Sunk Cost Fallacy is our tendency to follow through on an endeavor when we have already invested time, effort or money, whether or not the current costs of follow through outweighs the benefits.
We honor persistence. Giving up, we are told, is not an option. So, we continue to shovel money and time into the sinking ship. However, honoring sunk costs is irrational. There comes a point where we must back away, lick our wounds, and move on.
An Example of Sunk Costs Fallacy
An example of sunk cost reasoning is when we do something we won’t enjoy because we already spent the money for it. Let’s say you bought a couple tickets to a concert because the opening warm-up band has a guitar player you knew from college. You are excited to see the his band perform even though you don’t care much for the main act. The day of the concert you are notified that the warm-up band cancelled and will be replaced by a different small group you don’t care to watch. You decide to go to the concert anyway because you already purchased the tickets and don’t want to waist your money.
Logically, the money has already been spent (sunk costs) whether you go to the concert or not. A logical decision shouldn’t include consideration of the sunk cost but rather, whether going to the concert is more enjoyable than other things you could do with your evening.
Investments and Sunk Costs Fallacy
Irrational sunk cost thinking particularly interferes with investment choices. Consider owning an unusually large number of stocks in a particular company. The investment was risky but based on speculation that the company would develop a break through treatment for cancer. The research fails and the stock tanks. Sunk cost thinking keeps the stocks, hoping for a recovery, even though they would never consider buying the stock at this point, investing in a different stock with a brighter outlook.
In economic terms, sunk costs are costs that have already been incurred and cannot be recovered. The sunk cost fallacy means that we are making irrational decisions because we are factoring in the costs already incurred.
Loss Aversion and Sunk Costs Fallacy
Dan Ariely, a professor of psychology and behavioral economics at Duke University wrote that “our aversion to loss is a strong emotion, one that sometimes causes us to make bad decisions” (2010, location 2441). The sunk cost fallacy may occur in part because of this emotional reaction to loss. Losses feel much worse than the positive impact of gains. Our decisions, then, give undeserved weight to avoiding loss.
Christopher Olivola, an assistant professor of marketing at Carnegie Mellon’s Tepper School of Business and the author of a 2018 paper on the topic published in the journal Psychological Science, believes that people possibly irrationally continue in sunk costs because “they want to convince themselves that they’ve managed to recapture the loss” (Ducharme, 2018).
Rational Choice
According to rational choice theories, “only future prospects should affect current choices. Irrecoverable, previous incurred (sunk) costs should be irrelevant unless they inform the expectation of costs and benefits” (Vasconcelos, 2020). Olivola further explains, “the sunk-cost fallacy—pursuing inferior alternatives merely because we have previously invested significant, nonrecoverable, resources in them—represents a striking violation of rational decision making” (Olivola, 2018).
Books on Irrational Thought
A Few Words from Psychology Fanatic
We are not machines, only acting on cold data. Decision making is a complex process, involving emotions, ego, and other unseen forces. A cold rational “Spock” like reaction to decisions may serve well on the U.S.S. Enterprise but not in the world of human relationships.
As we fumble though our decisions, we should investigate distorting biases, such as loss aversion and sunk cost fallacy, and make corrections. However, occasionally, emotions provide guidance that rationality may overlook. In conclusion, we need both emotion and rationality to navigate the complex maze of life.
References:
Ariely, D. (2010). Predictably Irrational, Revised and Expanded Edition: The Hidden Forces That Shape Our Decisions. Harper Perennial; Revised and Expanded ed. edition.
Ducharme, J. (2018). The Sunk Cost Fallacy Is Ruining Your Decisions. Here’s How. Time. Published 7-26-2018. Accessed 8-26-2021.
Olivola, C. (2018). The Interpersonal Sunk-Cost Effect. Psychological Science, 29(7), 1072-1083.
Vasconcelos, M. (2020). The road ahead for sunk costs. Learning & Behavior, 48(1), 1-2.
