When did you first hear the phrase “throwing good money after bad”? Chances are you first encountered it when you were trying to weigh the pros and cons of overinvesting in something you’d already put a lot of money into. The phrase likely originated from the idea of a sunk cost, which is an economics term for the money and resources you’ve already spent that you’re never going to get back. Most of us are familiar with the concept but how does it relate to the sunk cost fallacy?
The sunk cost fallacy is a cognitive bias where people unintentionally influence their decision-making process when they have already invested time, money, or energy into something. Oftentimes, people will decide to keep investing in something they’ve already heavily invested in even when all signs are indicating it will not turn out to be a beneficial outcome. The problem with this irrational decision-making is that it keeps us from taking a cold, hard look at a situation and understanding if it’s still worth it to keep going or cut our losses and move on.
All of us have experiences with the sunk cost fallacy, whether we’re aware of it or not. We could be thinking of, for example, eating the meal at a restaurant you ordered, even if it’s bad, because you don’t want your money to go to waste. Or deciding to wear an uncomfortable pair of shoes because you’re already wearing them, not wanting to “waste” the money that was spent buying them.
Why People Fall For Sunk Cost Fallacy
The sunk cost fallacy is rooted deeply in our psychology and behavioral economics. People are more likely to stick with a purchased item, regardless of its quality, out of pride and or regret. Similarly, the more invested in the thing we’ve already put in, the less likely we are to move away from it and onto something potentially better.
Economist Richard Thaler, who won a Nobel Prize in 2017 for his groundbreaking behavioral economic studies, put it this way:
“The sunk cost fallacy is the situation in which people make decisions based on the money, time, or effort that has already been invested, rather than basing their decisions on the best current course of action going forward.”
This applies to more than just purchases too. People often find themselves staying in relationships, jobs, or living situations, even though those situations aren’t working out because they feel like they’ve already invested time and energy and they can’t bear to start over.
Avoiding Sunk Cost Fallacy
So, how can you avoid overinvesting in a particular decision to the point where it becomes a sunk cost fallacy? Here are some tips:
- Don’t fall for the sunk cost trap: Don’t be so swayed by how much you’ve already invested that you can’t see when it’s time to move on.
- Don’t over-commit: Know your limits and when it’s necessary that you be able to break away.
- Cut your losses: If a situation isn’t working out, don’t keep sinking money and time into it.
- Make decisions in the present: Don’t let past decisions affect decisions you make now.
- Stop the sunk costs from accruing: If you’re aware that you have a tendency to become too invested in a situation, be proactive and know when to cut your losses.
For example, if you find yourself spending more money than you should to make a project work, acknowledge it and re-evaluate the project. Maybe it’s officially time to cut your losses and move on or maybe there’s still some value in continuing. It’s important to be aware of this cognitive bias and work to overcome it instead of falling further into it.
Conclusion
Sunk cost fallacy can be an insidious trap that keeps us from making the best decisions and progressing. To avoid falling into the sunk cost fallacy, remember you’re in charge and be aware of how you’re falling into the trap. Re-evaluate your commitments before they become too costly and remember it’s never too late to cut your losses and move on.
Sources:
- Thaler, Richard H. 2017. “The Nobel Prize in Economics 2017”. The Royal Swedish Academy of Sciences.
- Cantor, Joel and Dana K. Papke. 2016. “Understanding The Sunk Cost Fallacy.” Investopedia.