Key Takeaway:
The sunk cost fallacy is a common tendency where people make decisions based on past costs rather than current events or future events. This can lead to high-stakes decisions and can affect choices that have bigger consequences for our lives. For example, Bob might base his decision on the original price of a house when the housing market crashes, but he doesn’t want to upgrade because he thinks it will cost more. This psychological tendency is called loss aversion. To make the most of sunk costs, consider joining a gym that charges a lot up front and only a small amount for each use, or paying for an online course that pays off in the long term.
A bad breakfast at the hotel while you’re on vacation? While you don’t really like the food options, you have to eat something because you paid for it when you made your reservation. You don’t go down the street to a cafe.
The “sunk cost fallacy” says that people can act in this way because they can’t forget about costs that have already been paid and can’t be recovered. When you’re deciding where to eat breakfast, the price you paid for the hotel package is an example of a sunk cost. You can’t get that money back, so you shouldn’t think about it.
As an example, finishing a boring book (or TV show) that you’re only halfway through can be justified by the time you’ve already “invested” in it. Another example is being less likely to leave exclusive groups like sororities and sports clubs if the initiation ritual required more work.
All of these actions don’t make sense, but they happen a lot, so it’s good to be aware of this tendency. You might even be able to use it to your advantage sometimes.
High-stakes decisions can be affected by sunk costs
The above examples show how common the sunk cost fallacy is, even though they may not seem very important. And it can change choices that have much bigger consequences for our lives.
Let’s say Bob bought a house for $1 million in the past. After that, the housing market crashes across the country. All the homes have dropped in price by 20%, and Bob can only get $800,000 for his. Bob wants to buy a bigger house because they are now cheaper, but he will need to sell his current home to get the money for a down payment.
He doesn’t want to upgrade, though, because he thinks it will cost him $200,000 more than the $1 million he paid for it in the first place. Bob makes the sunk cost fallacy by basing his decision on the original price of the house. The only price that should matter is the current and expected price of the house.
Even though Bob is acting crazy, he’s still a person. We may find it hard to ignore these kinds of losses because, psychologically, losses are more important than gains. This is called loss aversion.
The sunk cost fallacy is mostly shown by the choices people make, but it may also affect the choices groups make. In fact, this mistake is sometimes called the “Concord fallacy” because both the French and British governments kept funding the doomed supersonic airliner even after it became clear that it would not be able to make money.
War that lasts for a long time and costs a lot of lives on both sides is another example. Some people might think it’s impossible to give up because then the soldiers will have “died in vain.”
It can help you to know about sunk costs.
You should check yourself if you find yourself defending actions based on past costs rather than current events or what you think will happen in the future.
Figuring out what your “sunk costs” are lets you cut your losses early and move on, rather than letting them get worse over time. In the housing example, this is clear: the bigger the crash, the cheaper the bigger house is, but the bigger the crash, the bigger the loss that people think they will have when they sell their current home. As a result, the sunk cost fallacy causes more missed opportunities.
If the sunk cost fallacy is hard for you to get past, it might help to let other people make decisions for you. This could include the choice of whether to go to a buffet or subscribe to Netflix. The latter could be a double whammy: the flat fee structure could make you feel compelled to binge-watch, and as we already said, you might not finish mediocre series once you’re halfway through them.
Make the most of sunk costs.
You can use the fallacy to your advantage, which is a second, less obvious benefit. For instance, many gym memberships require payments up front, no matter how often you use the facilities. If you have trouble ignoring sunk costs, joining a gym that charges a lot up front and only a small amount for each use may help you stick to a regular gym routine.
This is also true for other things that cost you in the short term but pay off in the long term. For example, if you pay for an online course, you are more likely to stick with it than if you found a free course.
But be careful, this doesn’t always work. It turns out that spending a lot of money on a wedding or engagement ring doesn’t have a “sunk cost” effect, which means it doesn’t make people more likely to stay married.
