The sunk cost fallacy is a common decision-making pitfall about people’s tendency to continue investing time, money, or effort in a failing project/endeavor – simply because they have already invested a significant amount of time or resources.
Sunk cost fallacy – meaning and explanation
The sunk cost fallacy refers to the idea that we often make irrational decisions based on sunk cost. This means costs that cannot be recovered.
This tendency can lead to a situation where individuals continue to invest in a failing project or endeavor (even if the current costs outweigh the benefits of continuing to invest), simply because they do not want to waste their significant investment.
For example, suppose someone invests 1500 dollars in a stock that starts declining in value. Rather than cutting their losses and selling the stock, the individual continues to hold onto the stock in the hope that the value will recover.
In this example, the individual has already incurred sunk costs instead of making a rational decision based on the current value of the stock.
The impact of conscious and unconscious bias
Biases can influence the perception of the value of a project or investment, which relates to sunk cost fallacy.
For example, suppose an individual has a conscious bias towards a particular project. In that case, he or she may be more likely to continue investing in it even if it no longer makes sense to do so.
Similarly, unconscious bias can impact the perception of the potential success or failure of a project. This causes the individual to continue investing simply because they have already invested a lot.
In both cases, the two biases contribute to the sunk cost fallacy with the continued investing in a failing project.
What does the fallacy of sunk costs mean?
The fallacy of sunk costs refers to the same cognitive bias that is sunk cost fallacy. Both terms describe the same underlying concept and tendency to continue investing in a failing project.
The only difference between the two terms is semantics.
For example, some authors prefer to use the term “fallacy of sunk cost” to emphasize the irrationality of wasting to continue to invest in a failing project. In contrast, others use the term “sunk cost fallacy” to highlight the cognitive bias aspect of the phenomenon.
The impact of sunk cost fallacy
The impact of sunk cost fallacy can be significant, as it can affect individuals, organizations, and even whole societies.
Learn more about some of the most common impacts of the phenomenon below.
Wasting resources
One of the most apparent impacts of the sunk cost fallacy is that it leads to the waste of resources.
When individuals or organizations continue to invest in a failing project simply because they have already invested a lot, they only end up pouring even more resources into the lost cause.
This can harm their overall success and may even lead to financial ruin.
Poor decision-making
The phenomenon can also lead to poor decision-making.
When individuals or organizations become too invested in a particular approach or strategy, they may become blind to the facts and make irrational decisions based on their emotions rather than logic. This correlates with confirmation bias, which can exacerbate the sunk cost fallacy by making it harder for individuals to recognize when a project is no longer viable.
The result is that it can lead to poor decision-making, which can negatively affect the overall success of the individual/organization.
Reduced innovation
Another common impact of the sunk cost fallacy is the reduced level of innovation. When individuals or organizations become too invested in a particular project, they tend to become more resistant to change or new ideas.
This can stifle innovation and prevent new ideas from emerging, limiting progress and growth.
Opportunity cost
Finally, the sunk cost fallacy can lead to an opportunity cost. When someone continues to invest in a failing project, they may miss out on other opportunities that could have been more successful.
This can limit their potential for growth and success. Worst case, it can lead to missed opportunities that could have been game-changing for the individual/organization.
Examples of sunk cost fallacy in various areas
It can occur in both personal life, business, and international relations.
Below are some examples of individual and systemic effects.
Personal life
- Continuing to stay in a dysfunctional relationship simply because you have already invested time and effort in it.
- Refusing to switch to a different career path despite being unhappy in the current one because you have already invested time and money in education and training.
Business
- A company contributes to pouring money into a project that is no longer viable simply because they have already invested a large sum in it.
- A business refusing to let go of a product line that is no longer profitable since they have invested a lot of resources into it.
International relations
- A country continues to engage in a costly and ineffective war simply because they have already invested money and resources into it.
- A nation continues to support a failing international alliance since they have already invested significant effort into the alliance.
Overcoming the fallacy of sunk costs
Overcoming the fallacy of sunk costs requires a shift in mindset. Instead of focusing on the sunk costs that have already been incurred, individuals should focus on the future and make decisions based on the expected value of their investment.
Here are some tips for overcoming the sunk cost fallacy:
- Evaluate the current situation: Before making a decision, it is important to evaluate the current situation and determine whether the investment will likely succeed.
- Ignore sunk costs: Sunk costs have already been incurred, and there is nothing that can be done to change that fact. Therefore, any decision you make should be based on the current situation and not on the sunk costs that have already been incurred.
- Consider opportunity costs: In addition to evaluating the current situation, you must consider the opportunity costs of continuing to invest in a failing project. You may miss out on other opportunities by continuing to invest, so keep that in mind.
- Seek outside opinions: Overcoming the sunk cost fallacy on your own can often be tricky. Therefore, you can seek out the opinion of others to provide you with a different perspective, which might help you make a more rational decision.
