The sunk cost fallacy

Introduction

A few weeks ago I arranged a short weekend trip to Austria to meet a good Slovak friend of mine.

As always during the summer-season, hotels are expensive.

Occasionally you get special offers with a little less price though, with the disadvantage of getting your credit card charged instantly and refunding of money is not possible.

Two days before the meeting with all the expenses paid, my friend told me that it is not possible to come to Austria during the weekend (this was not her fault).

And so I had a hotel room booked and my credit card charged, but the actual reason to make this trip was gone.

What was my Plan B? Free weekends are a rather rare occurrence for me, so staying at home and doing some recreational activities such as hiking, reading, or cycling, would have been possible options.

Needless to say, I made the decision to go to Austria regardless, because, after all, I didn’t want to see my hard-earned money burnt.

The fallacy

Think about it for a second. Does this decision make sense for you?

Rather not, I suppose.

But why?

I was about to throw good resources (money for railway tickets, time for traveling, and so forth) after bad money.

Money that was completely lost (sunk) already. In admitting this, it would have made absolutely no difference if I had stayed at home or not.

What happened here was that I fell victim to a fallacy usually referred to as escalation of commitment or sunk cost fallacy.

Instead of doing some fun stuff, I decided to go to Austria with no particular plans or the promise that it would be worthwhile.

Sunk costs

Let’s take a brief but close look at the fallacy.

The starting point of our contemplation is the uncertainty of the future for a decision-making man.

If a decision is to be made, the human brain carries out an unconscious assessment of potential gains and losses and balances them against each other.

And here lies the crucial point: the brain doesn’t treat them equally. The prospect of a potential loss predominates the prospect of a potential gain, a direct result of the human evolution in the course of tens of thousands of years within a hunter and gather society where the most successful individuals were allowed to pass their genes to the next generation (that is on the flip side the reason for the notorious comfort zone too).

When one has to make decisions, a potential loss always outweighs a potential reward in the equation.

Seemingly this gains an evolutionary advantage, but this can also be a cause of irrational behavior of the modern man.

Sunk costs #1: Monetary investments

The text-book scenario is: after purchasing two tickets for two different events you find out that these events take place on the same day, and a refund of the money is not possible.

Most likely is that you will now attend the more expensive event (because the decision in the present moment is emotionally affected by the amount of money you’ve lost), though it is not necessarily that one which promises the better entertainment.

Nothing can reverse the fact that your money is sunk. So whatever option you will choose – you won’t get it back.

Sunk costs #2: Emotional investments

Sunk costs are not necessarily represented solely by money.

Stalled friendships or relationships are areas where the sunk cost fallacy can also be observed.

Have you ever wondered why people cling to their partner despite the foundation of their relationship is long gone?

They cling together because of a shared common history, because of emotional and financial investments or other commitments which have accumulated over the years.

It is almost the same with friendships. Why are a lot of people loyal to “friends” that they have nothing in common with but a remote past?

Sunk costs #3: Time

Time spent on courses, on a career, or on learning a particular skill (like a language or an instrument, for instance) can also become a sunk cost.

Many complete their course of studies despite realizing after three or even more semesters it is not that what they want to do in their professional life. But already passed exams (includes the time spent on preparation) and familiarity with the lectures make them stick to their subject.

A lot of employees with uninspiring jobs are loyal to their company despite having very little prospects for a career. Small accumulated raises and the overall predictability of their jobs make them stick to it.

One personal example: I trained martial arts for almost a decade, got quite good at it and was even able to get a few belt promotions, but eventually there came the point where I lost interest and passion for the sport.

From time to time I am still showing up to classes, nonetheless.

Money spent on training and the hundreds of hours on the mat were too big an investment just to be thrown away, though now, from an objective point of view, my spare-time would be better spend on doing something else.

Final thoughts

Potential gains are abstract, distant and unpredictable most of the time.

Bargains between potential gains and losses have to promise a heavy bias towards gains to take action. And a (sometimes not so apparent) sunk cost often triggers unpleasant emotions and hence impairs the decision-making ability.

I’ve fallen victim to the sunk cost fallacy more often that I’d like to admit and I don’t think that will ever change significantly, since biases are hardwired as like in every other human’s brain.

But I have at least some understanding how this comes about.

And so at least slightly improved odds not to fall victim to this fallacy again when making future decisions.