Sunk Cost Fallacy

Sunk Cost Fallacy

Sunk Costs are costs which have already been incurred and cannot be recovered. The Sunk Cost Fallacy is a mistake in reasoning in which you consider the sunk costs of an activity (instead of the future costs) when you decide whether you should continue the activity or not.

“I’ve put everything I have into this business. If I stop now all that time and money will be lost! I can’t stop now!”

The resources and effort are already lost, no matter what you do now. Therefore, the only thing you should worry about is what your goals are today, and most logical way to achieve them starting today.

Examples include:

  • “I’ve spent 5 long years at this crappy company, and I’m this close to getting a promotion, so I’m not giving up now.”
  • “I’m 3 years through my college career, and If accept this amazing job now, all that time will be lost.”
  • “I’ve spent a year renovating this drafty rat hole, if I sell before it’s done, all my effort will be wasted.”

The Danger of the Sunk Cost Fallacy

The danger comes in two flavors.

  1. By definition, anything you’ve tried in the past gets more weight than something you might try in the future:
    Resources and Effort Put in
    Stuff you’ve tried before Some
    Stuff you’ve never tried None

    You have always put “some” resources and effort into stuff you’ve already tried, and no resources or effort into stuff you haven’t tried yet. So if you fall for this trap, you will always favor the crap you’re doing now, over the changes you could make.

  2. The stuff you’re doing now, the stuff that isn’t working: that stuff is not going to start working. You think it will. I know you think the stuff you’re doing now (that isn’t working) will “maybe” start working because that’s the second flavor of the danger.

    The more resources a person pours into an activity, the more optimistic he is about it.

    Even if you ask yourself: “Would I accept a job at this company again, if I had just gotten the offer today?” you’ll probably answer yes, even if you really wouldn’t take it. Maybe the culture you expected didn’t pan out. Maybe you expected raises and promotions you never got, but always feel “close” to. Why will you think it’s still an okay deal? Because of the sunk cost fallacy: you’ve put so much time and effort into your employment that your puny psyche couldn’t stand the possibility that the time was a mistake.

How to Beat the Sunk Cost Fallacy

Bill Gracey @ Flickr

The calculation you need to make is whether the activity in question is worth what resources you haven’t put in yet, not what resources you already put in, which are gone forever no matter what you do.

Example of Ignoring a Sunk Cost

Imagine you’re planning a vacation to Florida since you can’t afford Hawaii. The vacation will cost $20,000 in total, and you have already paid a $10,000, non-refundable deposit. A week before the trip, your best friend calls you to tell you about a fantastic deal: if you go to Hawaii with him, you can go for only $10,000.

The cost of going to Florida to you is $10,000. The cost of going to Hawaii to you is also $10,000. You prefer Hawaii, so you should go there. The $10,000 Florida deposit is gone no matter what you do.

Techniques for Ignoring a Sunk Cost

Ongoing Activity

If you need to ignore the sunk costs of an ongoing activity like a relationship or job:

  1. Ask yourself: if I were just starting this today, would I think it was a good idea? Knowing what I know now about my job, would I accept an offer? If I met my wife today, would I be attracted to her? Knowing everything I know about her, would I marry her?

    This alone won’t work because of the dangers I talked about earlier. This is just to get you asking the right questions.

  2. Fictionalize the Situation. Instead of your wife Susan, imagine you’ve just met Betty. Imagine Betty with as much detail as you can: how tall is she, what color hair and eyes does she have, what does her voice sound like? Make her as real in your mind as possible. Make her as similar to your real wife Susan as you can.

    Now ask yourself the same question from above, but imagine it’s about Betty.

The idea is that you remove the sunk cost trap by first changing the context to one in which you have invested nothing (Susan is your wife, but Betty is a stranger), then considering the situation as it is now, not as it was when you began.

One Discrete Item

If you need to ignore the sunk costs of an item, like a college degree, then write down the cost of the item that you have yet to pay, then ask yourself: would I want this item if it cost me exactly what I have written down here?

You’re two years through a degree. It’ll cost you two or three years of effort, $50,000, and lost wages for those 2 years totaling perhaps $100,000. In exchange for your time and $150,000 you’ll receive certification which may help you find traditional employment in certain fields, and probably approval from your family. Will you take the deal?

Two Alternative Items

Often the question is about two alternatives. If you need to ignore the sunk costs of an item among alternatives, like the vacation from the example above, then:

  1. Write down the cost that you have yet to pay for each of the items.
  2. Write down the benefits from each of those items that you have yet to receive.
  3. For each alternative, follow the directions from above for one item to eliminate any alternatives that just aren’t appealing. Maybe something that sounded good in your head isn’t that great once you look at the costs and benefits in black and white.
  4. If there is more than one alternative left (there may be one or zero left), compare the written costs and benefits of each to decide which you prefer.

From the vacation example, we determined that the cost was the same for each, but we preferred Hawaii to Florida, so the choice was easy since we didn’t let the irrelevant detail of the deposit get in the way.

Conquering the sunk cost fallacy is a powerful tool for choosing a direction in life with confidence. It’s also a heck of a way to hone your financial and business decisions.

Did this article help clarify a decision you made recently? Could I have explained something better? Let me know!

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