Imagine you bought a ticket for a football game and on the day of the match you feel sick. Would you go because staying at home is a waste of money? If you answer “yes” the sunk cost fallacy is at work. The fact that you spent the money should not play a role in your decision; you can’t get it back. If going will make your life worse you should stay at home.
People like to think they make rational decisions based on the future value of something. But in reality many decisions are influenced by the time, money, love and/or energy invested. This makes it harder to abandon.
In Thinking Fast and Slow Kahneman and Tversky conducted an experiment to demonstrate the sunk cost fallacy. Imagine you go and see a $10 movie and lose $10 cash on the way to the cinema, would you still buy a ticket? In the experiment only 12% of the people said they wouldn’t. Now imagine you bought a $10 movie ticket and lost it. Would you buy another ticket? In this case a whooping 54% of the people said they wouldn’t. The situation is identical, in both scenarios $10 is lost, but in the case of the ticket it seems it was assigned to a specific purpose and then lost. This is the sunk cost fallacy at work.
Amateur investors make negative Expected Value decisions because of the sunk cost fallacy. They often base their trading decision on acquisition prices. If traders lose money on a stock they are, illogically, more hesitant to sell. The acquisition price should not be play a role in the decision; all that matters is the future value of the stock.
Professional poker players are aware of this flaw in thinking. Every dollar that a player puts in the pot is not theirs anymore and should not be a factor later in the hand. Professional poker players let the past not dictate their thought process; they are comfortable folding a hand without regard to the money invested.
The sunk cost fallacy manifests in many different ways: Do you keep reading a boring book that likely isn’t getting better? The time you’ve invested in reading the book is not important, if you don’t like it put it away. You only waste more time.
Our investment of time, money, love and/or energy is often the reason we carry on despite that we are dealing with a lost cause. Because of the sunk cost fallacy you keep reading a book you don’t like and hold on to stocks that should be sold. Investments that are gone and cannot be recovered should not matter in your decision making process; you should make rational decisions based on the future value.
Finally, apply this concept to your own life. Take a step back from the projects you currently invest time and money in and ask yourself; Am I working on these projects because of previous investments or are they still the best use of my time and money at the present moment?