Updated: June 5, 2023
Listen to this episode:
What is the sunk cost fallacy?
The sunk cost fallacy refers to our tendency to continue doing something simply because we have already invested time, money, or effort, even when the current or future benefits are minimal or non-existent.
In other words, we let past investments, which are sunk costs, influence our decision-making instead of objectively evaluating the situation.
Examples of the sunk cost fallacy:
For you to better understand how the sunk cost fallacy works, let me share some examples.
Example 1: A bad movie
Let’s suppose that you went to the cinema to watch a new movie.
However, after 30 minutes, you realize that the movie is terrible and you’re no longer enjoying yourself.
Despite this, you decide to stay and finish the movie because you’ve already paid for the ticket and don’t want to let it go to waste.
So you sat through another hour of bad acting and a mediocre story instead of just going out of the cinema and doing something that could be more fun or productive.
Example 2: A home renovation project
Imagine you decide to renovate your home, and you allocate a significant budget for the project.
As the renovation progresses, you encounter unexpected complications and additional costs.
The project begins to exceed both your initial budget and the estimated completion time.
Despite these challenges, you continue putting more money and time into the renovation, believing that you have to see it through since you’ve already invested so much.
However, suppose you objectively assess the situation and consider the current and future costs, as well as the impact on your finances and well-being, you might realize that continuing the project no longer makes sense.
Cutting your losses and redirecting your resources may be a more sensible decision.
Example 3: Stock investments
Suppose you invest in a stock that starts to decline in value.
As the stock price continues to drop, you might hold onto it because you don’t want to “realize” your losses.
You convince yourself that the stock will eventually rebound, even if the evidence suggests otherwise.
By holding onto a losing investment solely because of the money you’ve already invested, you fall victim to the sunk cost fallacy.
Dealing with the sunk cost fallacy:
Now that we understand the sunk cost fallacy and how it can impact our decision-making, let’s discuss some strategies for dealing with it effectively.
1. Accept the sunk costs.
Recognize that the time, money, or effort you’ve already invested is gone and cannot be recovered.
Instead of fixating on what you’ve already lost, focus on the present and future costs and benefits of the decision at hand.
2. Reevaluate the decision objectively.
Step back and evaluate the situation.
Consider the current and future costs, benefits, and risks involved rather than being swayed by past investments. Ask yourself if the decision aligns with your current goals and if it makes financial sense based on the available information.
3. Seek outside perspectives.
Sometimes, we can be too emotionally invested in a decision to think clearly. Seeking advice from trusted individuals, such as financial advisors or mentors, can provide fresh perspectives and help you see beyond the sunk costs.
4. Cut your losses.
If, after careful evaluation, you determine that a decision is no longer viable or aligned with your goals, be willing to cut your losses. Getting out of an unproductive investment or venture can free up resources and energy to pursue more promising opportunities.
The sunk cost fallacy is a common cognitive bias that can impact financial decision-making. We can make more rational and practical choices by accepting sunk costs, reevaluating decisions objectively, seeking outside perspectives, and being willing to cut our losses.
The 80 Percent Express are special short episodes where I share a financial concept or answer a question sent by a listener.
Ask me a question for the podcast: Send a voice message here.