Scenario 1: You have decided to watch a not so great movie. You do not book tickets online but decide to buy it at the theatre. When you reach the movie theatre, you realize you have lost a 10$ bill on the way. You still have money in your wallet. Would you buy a 10$ ticket to the movie?
You would have most likely said yes. 88% of the people do as per an experiment.
Scenario 2: You have already bought a movie ticket for the same not so great movie. At the theatre, you realize you have lost the ticket. Would you buy another ticket?
You might say yes, you might say no. But you thought longer than the previous scenario to decide. Only 46% of the people said they would buy another ticket.
Look at both the scenarios again. The cost of watching the movie at that point given the circumstances is the same 10$. However, your thought process varies in both scenarios. In the second scenario, you had spent those 10$ for watching the movie. Since you lose it, the loss makes you believe another 10$ may not be worth it.
In the first scenario, since the 10$ lost were unrelated, you do not stop yourself from buying the ticket.
I am writing a set of posts to help you identify how your brain plays games with you. The first article on this topic is the Sunk Cost Fallacy. You can read about all the biases of the mind by clicking here.
What is Sunk Cost Fallacy?
In economics, sunk cost means a cost paid which can no longer be recovered. The sunk cost fallacy urges you to continue doing what you are doing because you have invested time, money or energy in it. The more the money, energy or time invested, the harder it is to stop investing further time or money.
The first reason for the sunk cost fallacy is, the worry of loss bothers you and prevents your mind from accepting the loss. You, therefore, continue with the decision in the hopes of recovering the loss. Every delayed decision only makes it even harder to call it off.
As human beings, the pain of a loss hurts more than the joy of a gain.
Let’s take an example where I toss a coin and we bet. You lose 1000 on the wrong call. How much do you think you should win for the right call?
Very few people will agree on an even bet of 1000 for winning. Even if the odds of the coin landing head or tail are 50/50, people want odds stacked in their favor. This goes to prove the point that human beings worry more about a loss than the prospect of a gain.
The second reason for the sunk cost fallacy lies in the discomfort of accepting a mistake. For example, you decide to start a fast food restaurant of your own. Many people advise you that the location and the cuisine do not seem appropriate. In spite of the warning, you still go ahead with the venture and fail to make money.
Even if the reality has sunk in, you still want to turn the business around and make it successful because you do not want to appear wrong in the eyes of the world. You stick and put in more effort, time and money into a known bad decision due to the adamance of being right.
Sunk Cost Examples in daily life:
Sunk cost fallacy happens in daily life far more than you think. What you consider as usual decisions are sometimes triggered because of the sunk cost fallacy.
Eating till you choke because you pay for the buffet:
We are all guilty of this. Once we reach the buffet restaurant and take our seat on the table, we have to pay for the buffet. Whether you eat just one dish or all the dishes on the menu, the price does not change. However, since you paid for the buffet, you try to make up for it by showing the inner glutton in you.
The same happens when unlimited alcohol is offered at a prepaid price. We drink till we drop followed by a day of a bad hangover.
Investing more money in a business idea:
You run a business and you have invested a 500,000$ in adding a new product to the range of cosmetics you have. The product fails to sell well.
Since you have already invested a ton of money and effort, you decide to continue to try selling it some more. You invest money in marketing, online ads and provide offers thereby burning more money.
Kodak continued selling the old cameras with films when the digital cameras were selling like hotcakes. Their knowledge, investment, the experience of employees and the know-how of the old technology(along with a touch of arrogance) compelled them to persist with the old technology instead of making a drastic change.
Dating/Marriage involving a bad relationship:
You have been dating this person for 3 years now. The chemistry felt magical during the initial days. Over time, you realized the relationship was not healthy for both of you.
As much as you want to call it off, you find it impossible. Since you have spent 3 years already, breaking up would seem like the effort gone wasted and having to start over again.
If you had to make a similar decision when the relationship was only 2 months old, it would not seem hard, would it?
Watching a Boring Movie:
You purchased a ticket to a movie and you could barely make it halfway through. The story sucks, the direction is terrible and the actors make it hopeless.
At any point in time, you have a choice to walk out of the movie. However, you decide to complete the movie, even if you hate it because you have paid for the god damn ticket.
To make up for the cost of a ticket, you end up spending your valuable time.
Retaining old furniture:
Your chairs have turned old and you decide to replace them. The old chairs creak and look weak due to which you are unable to sell them. Though you can throw them away and save space, you decide to store them in the garage for future use.
Though the chances of using the old chairs seem nil, you do not want to discard the chairs you previously paid for.
Eat leftover food even after you are full:
You decide to dine at a Chinese restaurant. You order an appetizer and a main course dish. The waiter places 2 huge plates on your table which look a lot larger than you expected. You somehow manage to finish 70% of the food. At this point, you decide to finish the food because you have paid for it.
You convince yourself about not wasting food because somewhere in another part of the world a child goes hungry. The logic holds no good because at the point you feel filled to the brim, the leftover food is anyway wasted.
The food can only be discarded or eaten because no one will feed a hungry child with the leftover food on your plate(unless the restaurant has some arrangement). The only thing you gain from eating the leftover food after being full is a pile of unnecessary calories.
You could have avoided wasting food by asking for the portion sizes beforehand. Once the order is on the table, your best choice is to waste the additional food.
The same logic applies to a multitude of decisions like pursuing a branch of studies even when not liking it, reading a boring book through, driving further on an unplanned long drive to find a better spot and more. You are vulnerable to Sunk Cost fallacy on every damn day.
How Sunk Cost bias impacts your decisions:
If you watch your decisions closely enough, you will notice how much of an influence Sunk Cost fallacy has on your life.
I came all the way:
You drive a long way to buy a specific pair of shoes which you always wanted. When you reach the store the salesman tells you the shoes are out of stock. Now because you drove the distance you feel compelled to buy something.
Inability to sell old stuff:
Have you seen some real estate ads stay forever? The most likely cause is the owner values the property more than it deserves because he has paid for it. People go through a denial that the value is worth less than what they spent.
If the same person was asked what price would you pay to buy another house in the same area, he would say “I would pay X because the prices of the housing have dropped drastically in our city.”
Double standards are common when comparing the things that you own vs the things you want to own.
Incurring more losses:
If you have invested money and things go bad, backing out can seem difficult. A typical example lies in the stock market. If you have purchased a stock that loses value slowly over time(currently at 2000$), you continue hanging on to it hoping it will bounce back again.
You do not feel comfortable incurring a loss by selling at a price lesser than you purchased. On the other hand, if the stock went up by 2000$, selling at a profit won’t fetch you as much joy as the pain incurred by selling at a loss.
Taking bigger risks and losing more:
A common example of risking further to recoupe losses happens in gambling. If you entered a casino with 5000 $, spent 5 hours and lost 4000 of them, you will almost certainly bet the remaining 1000 too.
Your anger and frustration will lead you to think, “I spent 5 hours and have lost 4000, I have to make my money back.” Such decisions lead to more money lost.
Is sunk cost bias always bad?
Not necessarily. Sometimes the bias prevents you from making impulsive decisions. For example, filing a divorce because a few things went wrong may not be the best idea. Your bias of persisting with the relationship which you have already spent time on helps in keeping your relationship intact.
Also, many of the successful companies today exist because someone pooled effort and money continuously to make it happen. Starbucks was started after the investment was rejected many times. Harry Potter was published after a lot of publishers rejected JK Rowling.
Conclusion: How can you overcome Sunk Cost Fallacy?
If you are looking for your mind to stop influencing you with the sunk cost fallacy I have some bad news for you. Your mind will always value a loss more than a gain.
Selling a stock running on a loss will always seem harder. Breaking out of a long term bad relationship will always seem impossible. Also, as mentioned earlier, sunk cost fallacy does not have to always turn out bad. Sometimes it acts in your favor too.
Here are a few things you can do to reduce the impact of the sunk cost fallacy
- Ask yourself what are the factors influencing your decision. If the main reasons seem like past effort and money spent, rethink your decision.
- Involve another person in the decision. A second perspective on your thoughts can help you consider all angles.
- Consider what you are losing too. When you avoid deciding because you incur a loss, think about what consequences will you face if you took no-decision. For example, not selling a stock that is losing money can imply more money lost and lesser capital to buy quality stocks which will increase over time. Do not only look at a decision from the angle of loss.
- Use the 5-minute rule. Try to spend 5 quality minutes thinking all angles of a decision. Do not decide on impulse. Consider the teeny tiny details and reasons behind what your inner voice is telling you.
- Keep personal attachments aside. When you are dealing/selling with anything of your own, know that you value the item/idea/opinion more than the others do. Ask yourself if the emotional attachment is triggering an unnecessary impulse within yourself.
Your only counter against this flaw of your mind lies in awareness. When you know your mind can play such games with you, you can take a moment to step back and rethink your decision. With enough deliberate practice, rethinking the decision will seem like second nature.
What I am not:
What I am:
Continuously improving self-learner
Productivity/Time Management Obsessed