Sunk-Cost Fallacy

The sunk cost fallacy is a cognitive bias that occurs when people make decisions based on the amount of time, money, or effort they have already invested in a project or decision, rather than on the expected outcome or future costs and benefits. This could be bias leads people to continue investing in a project or course of action, even when it is no longer rational or beneficial, because they feel they have already invested too much to give up. This can result in poor decision-making and can prevent people from changing course or cutting their losses when it would be more advantageous to do so.

Here are a few examples of the sunk cost fallacy in finance:

1. Holding onto a losing investment: An investor may hold onto a stock that has been losing value for a long time, even when it becomes clear that the stock is unlikely to recover. This is because the investor has already invested a significant amount of money in the stock and does not want to take a loss.

2. Continuing to pay a high fee for a financial advisor: A person may continue to pay a high fee for a financial advisor even if the advisor is not providing any value, simply because they have already paid a lot of money for their services.

3. Investing more money in a failing business: A business owner may continue to invest more money in a failing business, even when it becomes clear that the business is not profitable. This is because they have already invested a significant amount of money and time in the business and do not want to give up.

4. Completing a project that is no longer necessary: A company may continue to invest time and money in a project even after it becomes clear that the project is no longer necessary or valuable. This is because they have already invested a significant amount of resources in the project and do not want to abandon it.

When making a decision whether to change or keep doing things the same. Don’t get stuck in “I’ve already put so much I to this, I just have to keep doing it.”

Here are some ways to beat sunk cost fallacy:

1. Recognize and acknowledge sunk costs: The first step in overcoming sunk cost fallacy is to recognize and acknowledge that the costs that have already been incurred are sunk and cannot be recovered. Accepting that the past cannot be changed helps you to make decisions based on the current situation and future prospects.

2. Reassess the decision: Ask yourself if the decision you are making is based on the current information or your past investment. If the current situation does not warrant the investment, you should consider abandoning the project and moving on.

3. Evaluate the value of the investment: Evaluate the value of the investment objectively and see if it aligns with your goals. Consider the opportunity cost of the investment and whether the resources could be better used elsewhere.

4. Seek advice: Seek advice from a neutral third party, such as a financial advisor or a mentor, to help you make an objective decision. A fresh perspective can help you see the situation in a new light.

5. Practice mental accounting: Practice separating the money that has already been spent on a project from future decisions. This way, you can make decisions based on the future value of the investment rather than past investments.

Remember, sunk cost fallacy is a common cognitive bias, and it takes time and practice to overcome it. By recognizing and acknowledging sunk costs, evaluating the value of the investment, and seeking advice, you can make better decisions and avoid throwing good money after bad.