A cognitive bias that describes the human tendency to let past investments of money, time, or energy in an activity influence decisions about whether to continue with that activity, regardless of the future costs or benefits.
Definition: One of the most common behavioural-economic mistakes that leads to financial decisions based on previous investments or expenses.
Example: Most people would risk travelling to a concert of sports game in dangerous weather if they had paid for an expensive ticket, while most would pass if they had been given the ticket for free.
Reference: Richard Thaler: described the Sunk Cost Fallacy in 1980, as a form of loss aversion.
Insight: We often throw good money after bad, because we cannot let go of money already spent.
Insight: We make poor decisions when we take into account money, time, or effort that we have spent in the past.
Insight: People may fall prey to the Sunk Cost Fallacy because they do not want to appear wasteful.
Insight: It is common for governments to spend as much money as possible on a project before it can be analysed, to exploit the sunk cost fallacy.
Insight: Money already spent shouldn't matter in financial decision making.
Insight: The sunk cost fallacy can explain why people stay too long in unhappy careers.
Principle: When making decisions, we should ignore money already spent, and focus on future costs and benefits.
Example: The decision whether or not to scrap an advertising campaign running for months without hitting any of its goals should not depend on the money already invested in it.
Example: The decision whether to leave a bad long-term relationship should not be based on the energy and love already invested in the relationship.
Insight: The Sunk Cost Fallacy becomes stronger the more money, time, or energy we invest in something.
Insight: Investors fall prey to the sunk cost fallacy when they base decisions on the acquisition costs rather than future expectations.
Insight: We often struggle to reverse a decision made in the past because we want to appear consistent with our decisions, and credible.
Principle: Forget past costs. Only assess future costs and benefits of a decision.
Example: Eating dessert at a restaurant when full just because you pre-paid for a set menu.
Insight: Even when we know about the principle of sunk costs, people find it difficult to ignore them.
Insight: Money paid in advance for tickets should not influence a decision about whether or not to go.
Insight: We fall victim to the Sunk cost Fallacy whenever we are reluctant to write off past efforts, and change direction or a decision even when we know it is better to do so.
Insight: We fall victim to the Sunk cost Fallacy whenever we take further risks to recoup past losses.
Reference: Seth Godin: quitting takes more guts that continuing. Humans hate quitting something we have investing time or money in, feeling that we have wasted it, even though it is already gone.
Insight: People make mistakes. Entrepreneurs take risks and sometimes fail. The problem comes when we fear taking responsibility for losses, and end up throwing good money and time after bad.
Key Insights & Principles
Personal Finance
Money already spent should not impact financial decisions.
We tend to make poor financial decisions when we account for money already invested.
The sunk cost fallacy often occurs because we do not want to appear wasteful, or we want to appear consistent and credible.
Ignore sunk costs. Only assess future costs and benefits.
Do not base investment decisions on acquisition costs, only future expectations.
Decision Making
We fall victim to the Sunk Cost Fallacy when we are reluctant to write off past efforts or investment, and change a decision, even when we know it would be best to do so.
Quitting takes more guts than continuing.
We make poor decisions when we fear taking responsibility for losses, and end up continuing to throw good time or money after bad.
The Sunk Cost Fallacy becomes stronger the more money, time, or energy we invest in something.
When making decisions ignore time, money, or energy already spent on an activity.
