Throwing good money after bad – Why We Fall Victim to the Sunk Cost Fallacy and How to Beat It
The Sunk Cost Fallacy
Imagine you have finally graduated from college, gotten a job, and are moving out of your childhood room at home and into a tiny room the size of a closet in the big city. You’re cleaning out and packing up old T-shirts you never wear, sweaters that went out of style years ago, and pants that just never fit you right. Since your apartment is so tiny, you barely have enough room in your closet to fit the clothes you wear on a daily basis, let alone all of these other items. But you love those T-shirts and the sweaters might come back into style and the pants might fit better if you lose some weight. So you pay for a storage unit in the city and waste some of your already very small income. Are you ever really going to wear those T-shirts again? Are those sweaters ever going to come back in style? You know the answer is probably not, and you also wouldn’t miss them if they were gone. But this is hard to remember when you think about all of the money you have already invested in all of these clothes. So instead, you choose to spend even more money on storage to keep items you spent money on in the past but don’t use in the present and probably won’t use in the future. What is this all about?
You are falling victim to sunk-cost fallacy. This cognitive bias refers to the act of making future decisions based on past investments. For example, when you have trouble throwing away those old clothes you are thinking to yourself, “what a waste to throw away these clothes I’ve spent all this money on,” even though you never wear those clothes anymore and clearing them out would open up space for clothes you actually do wear. We are the only animals that act in this irrational way – even rats are smarter than us and keep looking for rewards in the future rather than dwelling on the past.
Why am I doing this?
So, why are we falling into this trap? The sunk-cost fallacy is explained by a behavioral economics theory called
The trap we fall into – just because we have invested in the past, doesn’t mean we should keep investing.
http://www.cultivatechangeconsulting.com/tag/sunk-costs-fallacy/
prospect theory, which describes how we make decisions when there is risk involved (Kahneman & Tversky, 1979). Within prospect theory, the phenomenon called loss aversion – which means we are willing to give up a lot of potential reward to avoid a chance of a loss – explains why we so easily commit the sunk-cost fallacy. We fear the pain of losing much more than we value the reward of winning (Kahneman & Tversky, 1991). In an interview with the New York Times, Kahneman explains this with the example of flipping a coin. He proposes the following scenario: if I flip a coin and you get tails, you lose $10. How much money would you need to gain by getting heads in order to commit to the coin toss? Turns out, it’s at least $20, or over double what you would lose by landing on tails. We hate the consequence of losing way more than we value the feeling of winning.
If we are making these irrational decisions, there must be some reason why, right? A study by Baliga & Ely (2011) found that the sunk-cost fallacy may be a response to our limited memory capacity, meaning that our memory can only hold so much. As new information arrives over time, we may not be able to remember why we started a project in the first place due to our limited memory capacity. The Concorde effect, named for the British and French governments that continued to fund the Concorde aircraft even after it was clear that it was a bust, tells us that investors are more eager to complete a project when the sunk costs are high because they interpret this to mean that at the start of their project, they were optimistic about their future outcomes due to the large amount they invested in the endeavor (Dawkins & Carlisle, 1976). As new information arrives throughout the project’s lifetime, you may not be able to remember all of the reasons you started the project in the first place, but the sunk costs serve as a placeholder for this loss of memory due to our limited capacity. For example, say you are four years into your PhD and you aren’t so sure you want to be a professor anymore or why you even started this thing in the first place, the reminder of the cost you put into getting your PhD (years of your life with very low pay) is encoded, or stored in memory, as a mnemonic device to remind you of your original motivation to go through with the PhD. So, while this fallacy just seems like something that tricks us into keeping too many clothes or wasting money on projects, it can also serve a positive purpose by motivating you to trudge through and complete that PhD. Sure, the very rational rat we talked about before may not have made this decision, but while maybe it’s a little irrational, the sunk cost fallacy can help us remember why we started something in the first place and stick to it when times get tough.
Don’t fall into the trap!
It’s time to make the decision: to get rid of your old clothes or to pay for a storage unit? https://www.dreamstime.com/stock-photo-messy-closet-overfilled-clothes-colorful-woman-hangers-stuffed-any-available-space-image71804965
But, for those times when we would prefer not to fall victim to the sunk-cost fallacy, how can this be avoided? The core concept to helping avoid this fallacy is metacognition, which means thinking about your thinking. In our decision process to continue or stop a project, we often weigh the cost of a sure loss too greatly and do not give enough weight to viable alternatives (Hafenbrack, Kinias, & Barsade, 2013). Molden & Hui (2011) created a way of thinking about these losses to help us avoid relying too much on prevention-focused motivations, which focus on maintaining a sense of security, and transferring our focus to promotion-focused motivations, which look for alternatives and opportunities for growth. Let’s go back to our original example of deciding whether or not to pay for a storage unit to store all of your old clothes. If we allow our thoughts to be prevention-focused, our decision of whether or not to buy the storage unit will be motivated by our reluctance to give away clothes we have had for so long. Our thinking will be focused on the sure loss of old clothes, and therefore this loss will be weighed heavily in our decision making process. However, if we use metacognition to consciously shift our thoughts from being motivated by prevention to being motivated by promotion, we can think about the positive aspects of getting rid of our old clothes, like saving money on a storage unit and having more room for new clothes. By adopting this form of motivation, we are able to de-escalate our commitment to our past purchases and redirect our focus to the positive outcome that can come from letting go of something that just isn’t working.
We now know that it is easy to weigh our losses too greatly, so in addition to using metacognition to change our frame of thinking, what else can be done to avoid investing in something that is just not worth it? One study found that participating in mindfulness meditation, which literally means being aware of the present moment we are in, can help us direct our focus to the present and not lament our past decisions (Hafenbrack, Kinias & Barsade, 2013). By doing this we reduce the negative affect associated with giving up on an investment and increase our resistance to the sunk-cost fallacy. For example, if you have purchased a stock that keeps falling, it can be difficult to sell it and gain some of your money back because of the larger amount of money you have already invested in it. By focusing on long, deep breaths entering and leaving your body, instead of focusing on your past investment, you can bring your thoughts to the present to make a smart decision about selling your stock.
So the next time you are considering adding to an already considerable investment, stop and breathe. Focus on the present and future value of the clothes you are paying to store – or the PhD you need to complete – and you will be more likely to come to a rational decision and avoid the sunk cost fallacy.
References
Baliga, S., & Ely, J. (2011). Mnemonomics: The Sunk Cost Fallacy as a Memory Kludge. American Economic Journal: Microeconomics, 3(4), 35-67. Retrieved from http://www.jstor.org/stable/41330450
Dawkins, R., and T. R. Carlisle. 1976. “Parental Investment, Mate Desertion and a Fallacy.” Nature, 262(5564): 131-33
Hafenbrack, A. C., Kinias, Z., & Barsade, S. G. (2014). Debiasing the mind through meditation mindfulness and the sunk-cost bias. Psychological Science, 25(2), 369-376.
Kahneman, D., & Tversky, A. (1979). Prospect theory: An analysis of decision under risk. Econometrica: Journal of the econometric society, 263-291.
Molden, D. C., & Hui, C. M. (2011). Promoting de-escalation of commitment a regulatory-focus perspective on sunk costs. Psychological Science, 22(1), 8-12.
Tversky, A., & Kahneman, D. (1991). Loss Aversion in Riskless Choice: A Reference-Dependent Model. The Quarterly Journal of Economics, 106(4), 1039-1061. Retrieved from http://www.jstor.org/stable/2937956
Hi Mollie! First of all, thank you – you’ve made me think about how much I am spending and adding to an already ‘considerable’ amount. I think I will think more rationally when shopping, or at least I will reconsider my options before sticking to the original one.
I really liked your post. I think that images and memes you are using are very funny, and catchy (hint – attention).
I have never really thought about decision making processes until this semester, and your explanation of the sunk cost fallacy bias is on point. As most of the decision making processes, the suck fallacy bias is also explained in behavioral economics theory, and is called prospect theory. Just like status quo bias, the prospect theory describes how we make decisions when there is risk involved. Another similarity to status quo bias is the phenomenon called loss aversion, explained in depth by Kahneman & Tversky, 1991. Another great point you made is the meditation, and taking a moment to re-think our decision. We can definitely all focus on the present by taking a moment to enjoy the mindfulness meditation, and raise our minds and awareness of the world around us, and the present moment we live in.
It is true that we are willing to give up a lot of possible gains in order to avoid a small chance of a loss, and that is also depriving us from new experiences. So what are we getting from the sunk cost fallacy? What are we getting from sticking to the status quo? Nothing really! We just have an excuse to explain to someone why we so easily commit the first or already existing choice, over novel ones. Just like you cited “We fear the pain of losing much more than we value the reward of winning (Kahneman & Tversky, 1991)”.
I suggest you look closely to other experiments to Kahneman and Tversky, if you wish to learn more on loss aversion and behavioral economics. You can look up some of my references, or just google them on ‘google scholar’.
Tversky, A., & Kahneman, D. (1991). Loss Aversion in Riskless Choice: A Reference-Dependent Model. The Quarterly Journal of Economics, 106(4), 1039-1061. Retrieved from http://www.jstor.org/stable/2937956
@Adela Ramovic
Thanks Adela! Glad you liked the post, and I really enjoyed reading more about loss aversion. The work of Kahneman & Tversky made me, too, think about the irrational decisions I am making!
Hey Mollie! This post was super interesting and really made me start thinking about my own spending and the difficulties I have getting rid of old clothing. I am definitely the kind of person who has trouble throwing away my old t-shirts just incase I’ll need them in the future – I never do.
This cognitive bias reminds me a lot of the one that I posted about on the Ostrich Effect. The Ostrich Effect describes the tendency people have to avoid conflict with the hopes that it everything will figure itself out on its own. After reading your post, I came to the realization that metacognition could have a large impact on those who fall victim to the Ostrich Effect. Similarly to how you said that people could avoid Sunk Cost Fallacy by thinking about their current situation and evaluating if they need a certain item of if they need to spend money on something unnecessary, people could avoid the Ostrich Effect by thinking about their current conflict and working to fix it instead of avoiding it. Studies have shown that avoiding our problems don’t necessarily solve them, and it can actually cause conflict in the workplace. Taking a moment to actually think about what is creating the issue – metacognition – could help it get resolved much more effectively and quickly.
It would be interesting to see if studies have looked into different situations where the Sunk Cost Fallacy is more prevalent. For example, are people more likely to hang on to clothes or furniture that needs to be replaced?