14/05/21
The film was dire. After an hour, I whispered to my wife: “Come on, let’s
go home.” She replied: “No way. We’re not throwing away three hundred bucks.”
“That’s no reason to stay,” I protested. “The money’s already gone.
This is the sunk cost fallacy at work—a thinking error!”
She glared at me,
I desperately tried to clarify the situation. “We have spent the three hundred bucks
regardless of whether we stay or leave, so this factor should not play a role
in our decision.” Needless to say, I gave in and sunk back down in my seat and had to suffer the rest of the movie.
A friend struggled for years in a troubled relationship. His girlfriend cheated on him time and again. Each time, she came back repentant and begged for forgiveness. He explained it this way: “I’ve invested so much energy in the relationship, it would be wrong to throw it away.” A
classic case of the sunk cost fallacy.
The sunk cost fallacy is most dangerous when we have invested a lot of time, money, energy, or love in something. This investment becomes a
reason to carry on, even if we are dealing with a lost cause. The more we
invest, the greater the sunk costs are, and the greater the urge to continue
becomes.
Our Investors frequently fall victim to the sunk cost fallacy. Often they base
their investment decisions on acquisition prices. “I lost so much money with
this stock, I can’t sell it now,” they say. This is irrational. The acquisition price should play no role. What counts is the stock’s future performance
(and the future performance of alternative investments).
Ironically, the more
money a share loses, the more investors tend to stick by it.
This irrational behavior is driven by a need for consistency. After all,
consistency signifies credibility. We find contradictions abominable. If we decide to cancel a project halfway through, we create a contradiction: We
admit that we once thought differently. Carrying on with a meaningless project delays this painful realization and keeps up appearances.
The Concorde is a prime example of a government deficit project. Even
though both parties, Britain and France, had long realized that the
supersonic aircraft business would never work, they continued to invest
enormous sums of money in it—if only to save face. Abandoning the
project would have been tantamount to admitting defeat. The sunk cost
fallacy is therefore often referred to as the “Concorde effect.” It leads to
costly, even disastrous, errors of judgment.
The Americans extended their involvement in the Vietnam War because of this. Their thinking: “We’ve
already sacrificed so much for this war; it’d be a mistake to give up now.”
Rational decision making requires you to forget about the costs incurred to date. No matter how much you have already invested, only your assessment of the future costs and benefits counts.
Don’t “throw good money after bad” and stay blessed forever.