Sunk Cost Fallacy – The Clear Thinking Project

Clear thinking is in extreme high demand. I believe it comprises certain skills like excellent risk management, good judgment, and equanimity under stress.

Having a good set of mental models is comparable to the mental map in the head of a good taxi driver who knows the way around the city. It helps to streamline the journey through town, know the best time to be on the road, where to find good parking spaces, and how to circumnavigate around congested streets and intersections.

I am attempting to write a series of blog posts about mental models that attribute to the mental discipline of clear thinkers. My motives are completely selfish here, because I don’t want to make more obvious mistakes in my life.

Clear thinking gives you the confidence to take calculated risks and escape the timidity or rashness of other people.

One of the strongest advantages of clear thinking is that it also helps you travel light.

I’ll explain.

Most of us are walking around with a heavy head carrying within a lot of dead weight based on events, decisions, and actions carried out in the past.

Ergo, Sunk Cost.

Sunk Cost is a term that describes the unreasonable psychological attachment we humans have towards anything that we have spent, consumed, discarded, or wasted in the past.

“Sunk Costs: Money you already spent shouldn’t influence your decision about what to do next, but for psychological reasons it often does.” —Scott Adams, “Loserthink.”

Money spent is something that you can not get back or recover. It’s in your past and it’s a done deal. It’s a sunk cost.

Money spent on marketing and advertising, for instance, is a sunk cost. If the product doesn’t sell, what you already spent on its promotion is a sunk cost that should have no effect on future decisionmaking.

Research and development of a new technology or a product is also a sunk cost. If the end product or service prove to be ineffective or a failure, it’s a sunk cost and the money spent shouldn’t be considered in future R&D projects.

Money spent on stock market investments in a growth stock that goes bust is a sunk cost because you can never recover the value you invested.

Money and time spent training your workforce to use a new technology, new software, or to learn new skills that later on prove to be useless, ineffective, or unnecessary, must be considered sunk cost because what’s done is done and we can’t turn back the clock.

When you go overboard and pay for a very large meal to entertain friends and family at home and then fate intervenes with a weather event that makes it impossible for anyone to come over. You can’t return the food, you can’t eat it all, and you don’t have storage in your freezer for everything. That food and the money you spent on it is a sunk cost.

Sunk Cost Fallacy is the tendency to continue to pursue a certain course of action, or certain behavior, and continue to pour resources of time, money, and labor into a project simply because you are considering the amount, weight, momentum, or the sheer extravagant cost of the previously invested resources.

Let’s say you went to college to study mechanical engineering and after a couple of years you decided that you really loved computer science instead. The time already spent studying mechanical engineering should be considered sunk cost and your switching to study computer science should be made as soon as possible. The sunk cost fallacy is affecting you if you just keep studying mechanical engineering even though you don’t have any deep interest in it simply because you don’t want to squander the time and money you spent already.

Now consider the following two thoughts running through the mind of a person facing a sunk cost dilemma:

–”I’ve already spent so much on this, I can’t stop now. I just need to focus, persevere, and have the stamina and patience to see this through.”

–”No, I don’t have to keep going down that path if it’s not working out or has proven to be a complete waste. I just must stop the bleeding, cut my losses, and move on before it’s too late.”

This is a classic Sunk Cost dilemma. You’re torn between the size of your investment and how it is not showing any progress or positive returns and the thought that you are giving up too early and acting like a quitter when everything worthwhile takes a long time to develop.

Investments of time, money, and resources do matter, however, because we had certain expectations when we made them that they should work out and produce specific results.

So, how do we decide when it’s not clear whether the costs are outweighing the benefits or the other way around?

Photo Credit: The Decision Lab

“The sunk cost fallacy occurs because we are not purely rational decision-makers and are often influenced by our emotions. When we have previously invested in a choice, we are likely to feel guilty or regretful if we do not follow through on that decision. The sunk cost fallacy is associated with the commitment bias, where we continue to support our past decisions despite new evidence suggesting that it isn’t the best course of action.”The Decision Lab

Awareness of our own biases and limitations is the key to figuring out when and where we’re making a judgment error. If we understand that commitment bias drives us to conform to our past behaviors, our past reputation, and our public image, then we know how it can work for, and against us.

You can make commitment bias work for you when you make a public statement that you are going to quit smoking, or lose weight, or write a book, etc. You are more likely than not to commit to a publicly made statement because it affects your reputation, your social standing, and your self-esteem.

Commitment bias might be playing a role in a well-known persuasion principle first taught by Dale Carnegie: give others a fine reputation to live up to. When you attach a certain excellent character trait or a favorable reputation to the person you want to influence, you inadvertently create in them the need to commit to your characterization of them. They don’t want to disappoint you, they would like adhere to the image you painted for them, and they are willing to behave in a way congruent with your pitch or offer. It’s a famous trick performed regularly by salespeople.

Photo Credit: Investopedia

Another factor that might be affecting the Sunk Cost Fallacy is Loss Aversion Bias. It’s our built in system that makes us extremely sensitive to loss and desensitized to gain. A person who has a choice between “not losing money” and “gaining more money” will favor not losing money by default.

Loss aversion bias pushes us towards not following through on any investment of time and money because of the fear of losing all those past investments.

If you consider all these factors, you suddendly understand why people tend to make use of things they had to pay for while they tend to ignore and abandon anything they’ve gotten for free.

Sunk cost, commitment bias, and loss aversion bias all push us towards placing a high value on things we had to pay for with our hard earned cash and the highest value commodity that is our time.

People who gain their wealth through hardships and lengthy investments of time, money, effort, relationships, and learning from mistakes, place an extremely high value on their hard-earned money and assets.

On the other hand, people who win the lottery and gain a windfall of millions of dollars, have no appreciation for the real value of their newly found wealth. They did not have to work for it; it was just handed to them on a platter.

As you can deduce here, it is quite possible for you to make very good use of these behavioral tendencies and make them work to your advantage.

Quite simply you can be fairly sure that you are going to follow through on reading a book if you actually go buy the book and not just borrow it or get a free pirated copy online.

You can make it very likely that you are going to go through with your plan of losing excess weight and working out if you make that decision in public which constitutes a significant investment of personal reputation. You trick your ego, in a sense, to push you towards keeping your image as a person who does what they say.

You can also try to make better decisions based on the information that you have of the situation you are facing in the present and the consequences of the actions you can take right now. Commitment to decisions or actions made in the past should be revised with a clear understanding of Sunk Cost.

People who are always stressed out and struggling because they keep revisiting their actions in the past are neck deep into the Sunk Cost Fallacy.

The past is gone forever.

You don’t have any control over past events. You played your card the best way you knew how at the time, but with time passing comes knowledge and awareness that can help us reassess our decisions regardless of how much we hadcto sink into an investment of time, money, emotions, or other resources.

Even the future doesn’t matter. All that you can influence and manipulate is the present.

Time travel does not exist and it doesn’t benefit you to dwell in the past overanalyzing everything that’s happened, worrying about it, as it doesn’t serve you at all to live in fear of the uncertainties of an unknown future.

Be right here, right now, put everything in the balance of the present and weigh your actions based on what you know right now and what you can control this very moment.

Be present.

***

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