Why are we likely to continue with an investment even if it would be rational to give it up?

 

The Sunk Cost Fallacy

, explained.

What is the Sunk Cost Fallacy?

The Sunk Cost Fallacy describes our tendency to follow through on an endeavor if we have already invested time, effort or money into it, whether or not the current costs outweigh the benefits.

Where this bias occurs

Imagine that you bought a concert ticket a few weeks ago for $50. On the day of the concert, you feel sick and it’s raining outside. You know that traffic will be worse because of the rain and that you risk getting sicker by going to the concert. Despite the fact that it seems as though the current drawbacks outweigh the benefits, why are you still likely to choose to go to the concert?

This is known as the sunk cost fallacy. We are likely to continue an endeavor if we have already invested in it, whether it be a monetary investment or effort that we put into the decision. That often means we go against evidence that shows it is no longer the best decision, such as sickness or weather affecting the event.

Individual effects

In economic terms, sunk costs are costs that have already been incurred and cannot be recovered.1 In the previous example, the $50 spent on concert tickets would not be recovered whether or not you attended the concert. It therefore should not be a factor in our current decision-making, because it is irrational to use irrecoverable costs as rationale for making a present decision. If we acted rationally, only future costs and benefits would be taken into account, because regardless of what we have already invested, we will not get it back whether or not we follow through on the decision.

The sunk cost fallacy means that we are making irrational decisions because we are factoring in influences other than the current alternatives. The fallacy affects a number of different areas of our lives leading to suboptimal outcomes.

These outcomes range from deciding to stay with a partner even if we are unhappy because we’ve already invested years of our lives with them, to continuing to spend money renovating an old house, even if it would be cheaper to buy a new one, because we’ve already invested money into it.

Systemic effects

The sunk cost fallacy not only has an impact on small day-to-day decisions like attending a concert. It also has been proven to impact the decisions that governments and companies make.

A famous example of the sunk cost fallacy impacting large-scale decisions was coined the Concorde fallacy. In 1956, the Supersonic Transport Aircraft Committee met to discuss building a supersonic airplane, the Concorde.2 French and British engine manufacturers and French and British governments were involved in the project that was estimated to cost almost $100 million dollars.3 Long before the project was over, it was clear that there were increasing costs and that the financial gains of the plane, once in use, would not offset them.4 However, the project continued. The manufactures and governments followed through on the project because they had already made significant financial investments and dedicated a lot of time to the project.4 Ultimately, this led to millions of dollars being wasted, and Concorde operated for less than 30 years.2

If governments and large companies like those involved in the Concorde project are susceptible to cognitive fallacies like the sunk cost fallacy, it is easy to see that significant amounts of money, time and effort are wasted because the sunk costs would never be recovered regardless of whether the project was abandoned. Since governments are sometimes using tax-payers’ money for projects, their adherence to the sunk cost fallacy can negatively affect us all.

Why it happens

The sunk cost fallacy occurs because we are not purely rational decision-makers and are often influenced by our emotions. When we have previously made an investment into a choice, we are likely to feel guilty or regretful if we do not follow-through on that decision. The sunk cost fallacy is associated with the commitment bias, where we continue to support our past decisions despite new evidence suggesting that it isn’t the best course of action.

We fail to take into account that whatever time, effort or money that we have already expended will not be recovered. We end up making decisions based on past costs and instead of present and future costs and benefits, which are the only ones that rationally should make a difference.

The sunk cost fallacy may in part occur due to loss aversion, which describes the fact that the impact of losses feel much worse to us than the impact of gains. We are more likely to avoid losses than seek out gains. We may feel that our past investment will be ‘lost’ if we don’t follow through on the decision, and make a decision based on loss aversion rather than consider the benefits that would be gained if we did not continue our commitment.

One of the reasons not following through on a decision leads to a feeling of loss is because the overall endeavor gets framed together, instead of in stages. If we fail to follow through on a decision, the narrative is one of failure, even if the subsequent decision not to continue to commit was actually in our best interest. Even if costs are higher when we decide to follow through on a decision, such as going to the concert despite the rain and a cold, we can still frame the narrative as an overall success. Otherwise, the story would be that we wasted $50, not that we made an intelligent decision for our health and wellbeing.

Why it is important

As can be seen by the various examples discussed in this article, the sunk cost fallacy impacts many aspects of our daily life, as well as bigger decisions that have long-term effects. The sunk cost fallacy means that we are making decisions that are irrational and lead to suboptimal outcomes. We are focused on our past investments instead of our present and future costs and benefits, meaning that we commit ourselves to decisions that are no longer in our best interests.

The sunk cost fallacy is a vicious cycle because we continue to invest money, time and effort into endeavors that we have already invested in. The more we invest, the more we feel committed to continuing the endeavor, and the more resources we are likely to put in to follow through on our decision.

How to avoid it

While it is difficult to overcome inherent cognitive fallacies, if we are aware of the sunk cost fallacy, we can try to ensure we are focusing on current and future costs and benefits instead of past commitments. We should focus on concrete actions instead of the feeling of wastefulness or guilt that accompanies dropping an earlier commitment, as studies have shown that when we are deterred from making decisions based on our emotions, the effects of the sunk cost fallacy are reduced5.

However, it is difficult for us to ignore our emotions as they are powerful influences on our decisions. Instead, we can turn to technology to help us make decisions. Information technology systems make rational choices and are not impacted by the chain of decisions that came before6.

How it all started

Behavioral scientists and economists are constantly trying to understand the reasons as to why we make irrational decisions. Richard Thaler, a pioneer of behavioral science, first introduced the sunk cost fallacy, suggesting that “paying for the right to use a good or service will increase the rate at which the good will be utilized” (1980, pp. 47).7

Two important psychologists, Hal Arkes and Catherine Blumer, wanted to examine the sunk cost effect in practice in order to expand Thaler’s definition beyond money. They defined the fallacy as “a greater tendency to continue an endeavor once an investment in money, effort, or time has been made” (1985, pp. 124).8

Arkes and Blumer conducted several experiments to show that people were influenced by the sunk cost fallacy in their decision-making. The first experiment was a questionnaire study, where participants were asked to imagine that they had spent $100 on a ski trip to Michigan and later $50 on a ski trip to Wisconsin, without realizing that the tickets were for the same weekend. They were told they thought they would enjoy the Wisconsin trip more. Participants were then asked which of the ski trips they would go on if it was too late to return either ticket.

54% of participants said they would go on the Michigan trip, despite the fact that the rational choice would be to go on the ski trip that would be most enjoyable, because costs are lost either way. Arkes and Blumer concluded that over half of the participants chose Michigan because they had made a greater initial investment, providing evidence for the sunk cost fallacy.

Arkes and Blumer wanted to ensure that the sunk cost fallacy was still apparent in a real-life situation rather than in a hypothetical questionnaire. The researchers decided to provide discounted seasonal tickets at a theatre to see if the money spent on a ticket affected how often people attended the shows.

People either paid the normal price ($15), were given a $2 discount, or were given a $7 discount, but only after indicating that they wanted to buy a seasonal ticket (this showed that they were willing to pay the normal price). Arkes and Blumer then recorded how many shows each individual went to and found that individuals in the no-discount group went to an average of 4.11 shows, compared to 3.32 shows for the individuals in the $2 discount group and 3.29 shows for the individuals in the $7 discount group. Arkes and Blumer concluded the reason for the difference between groups was because the no-discount group had the greatest sunk costs, and therefore continued to invest their time into going to the theatre.8

Example 1 - Education decisions

Investing in education requires a lot of effort, time and money, often before the education actually begins. The costs of education can therefore be thought of sunk costs.

Since education can be very expensive, with postsecondary institutions in the U.S being a $584 billion-dollar industry in 2016-2017,9 psychologist Dr. Martin Coleman wanted to see whether the sunk cost fallacy comes into play with regards to decisions to continue education.10

Colemans’ participants were all told that they had been offered a job that required them to obtain a qualification in communication skills that cost around $100. They were told that their employers said all the courses were the same and they could take any of them. Participants were told that they found one that had a 75% pass rate, that for today-only, had a discounted rate. Some participants had the discounted rate set at $50, others $100, and others $150, and they were told they signed up so as not to miss the deal.

Participants were then told that their friend had found an identical course that had an 85% success rate that was free, so they had signed you up. Participants were then asked the following questions:

Do you go to the college classes that you spent an under/ on/ over budget amount on? Do you go to the free classes with the better chances of success, or do you attend a few of each?

The rational decision would be for participants to go to the classes that had an 85% pass rate, as this is the decision that makes them most likely to succeed. However, Coleman found that participants that had spent over budget ($150) were significantly more likely to remain committed to the initial course even with the lower pass rate, compared to those participants that had spent under budget on the initial course.10

This study suggested that the more money we initially invest in education, the more likely we are to continue with it because of the sunk cost fallacy.

Example 2 - Watching boring movies

Have you ever realized 30 minutes into watching a movie that you don’t enjoy it, but continue to watch it anyway? This is because of the sunk-cost fallacy. We continue wasting our time on a boring movie since we have already invested 30 minutes of our time into it.

The likelihood that we will continue watching a boring movie is even greater the younger we are. JoNell Strough, a psychologist interested in how age affects decision-making, along with a team of researchers, investigated this phenomenon.11

Participants in Strough’s study were between 18-27 years old or between 58-91 years old. All participants saw vignettes of two scenarios. In the first scenario, participants were told they had paid $10.95 to watch a movie on pay-TV, and that five minutes later, they were bored and it seemed like a bad movie. In the next vignettes, participants saw the same scenario except with the financial investment removed. Participants were then presented with five options for each of the two scenarios: stop watching entirely, watch for five more minutes, watch for ten more minutes, watch for thirty more minutes, or watch until the end.

Strough found that participants in the 58-91-year-old age group were less likely to fall victim to the sunk cost fallacy, meaning they were less likely to watch the movie until the end or continue watching it for an extended period of time. Additionally, older participants were more likely to be consistent with their decision for both of the scenarios. Strough concluded that younger people are more likely to be influenced by the sunk cost fallacy and are less consistent with their decisions.11

Summary

What it is

The sunk cost fallacy describes our tendency to continue to pursue an endeavor that we have already committed to in terms of investing money, time or effort into it, even if those costs are not recoverable.

Why it happens

The sunk cost fallacy occurs because our emotions often cause us to deviate from rational decisions. Abandoning an endeavor after committing to it and investing resources into it is likely to cause negative feelings of guilt and wastefulness. Since we want to avoid negative feelings of loss, we are likely to follow through on a decision that we have invested in even if it is not in our best interest.

Example 1 – Education choices

Education is a billion-dollar industry in the U.S, and often, we are asked to pay for educational programs in advance. Once we have paid for a particular program, we are unlikely to drop it even if we find a free program with a better success rate, because we have already invested money into a program.

Example 2 – Boring movies

The sunk cost fallacy also impacts smaller day-to-day decisions, like continuing to watch a movie even if it is boring. We are likely to continue watching a movie if we’ve invested both time and money into it even though those investments cannot be recovered by continuing to watch the movie. Age seems to have an impact on how much time we are willing to continue watching the movie, with younger people being more susceptible to the sunk cost fallacy.

How to avoid it

Since the sunk cost fallacy is thought to be caused by our desire to avoid negative emotions, we should try to take our emotions out of the equation when making a decision. However, emotions are powerful and hard to ignore. Instead, we may want to use technologies to help us make decisions when it comes to scenarios where we might be influenced by the sunk cost fallacy.

Sources

  1. Bondarenko, P. (2015, November 23). Sunk cost. Encyclopedia Britannica. https://www.britannica.com/topic/sunk-cost
  2. Blasingame, J. (2011, October 3). Beware of the Concorde fallacy. Forbes. https://www.forbes.com/sites/jimblasingame/2011/09/15/beware-of-the-concorde-fallacy/#5655b8334e22
  3. Amirani, A. (Director). (2003). Concorde: A Love Affair [Timewatch episode]. BBC.
  4. Arkes, H. R., & Ayton, P. (1999). The sunk cost and Concorde effects: Are humans less rational than lower animals? Psychological Bulletin, 125(5), 591-600. https://doi.org/10.1037/0033-2909.125.5.591
  5. Jarmolowicz, D. P., Bickel, W. K., Sofis, M. J., Hatz, L. E., & Mueller, E. T. (2016). Sunk costs, psychological symptomology, and help seeking. SpringerPlus, 5(1), 1-7. https://doi.org/10.1186/s40064-016-3402-z
  6. Herrmann, P., Kundisch, D., & Rahman, M. S. (2015). Beating irrationality: Does delegating to IT alleviate the sunk cost effect? SSRN Electronic Journal, 61(4), 831-850. https://doi.org/10.2139/ssrn.1941331
  7. Thaler, R. (1980). Toward a positive theory of consumer choice. Journal of Economic Behavior & Organization, 1(1), 39-60. https://doi.org/10.1016/0167-2681(80)90051-7
  8. Arkes, H. R., & Ayton, P. (1999). The sunk cost and Concorde effects: Are humans less rational than lower animals? Psychological Bulletin, 125(5), 591-600. https://doi.org/10.1037/0033-2909.125.5.591
  9. National Center For Educational Statistics. (n.d.). Fast facts: Expenditures. Retrieved August 17, 2020, from https://nces.ed.gov/fastfacts/
  10. Coleman, M. D. (2010). Sunk cost, emotion, and commitment to education. Current Psychology, 29(4), 346-356. https://doi.org/10.1007/s12144-010-9094-6
  11. Strough, J., Mehta, C. M., McFall, J. P., & Schuller, K. L. (2008). Are older adults less subject to the sunk-cost fallacy than younger adults? Psychological Science, 19(7), 650-652. https://doi.org/10.1111/j.1467-9280.2008.02138.x