The film was awful. After an hour, I whispered to my wife – come on, let’s go home. No way, we are not throwing over Rs 1,000, she retorted.
Reflect: That’s no reason to stay, I protested. The money is gone and it’s over and out. This is a classic case of sunk cost fallacy at work – the thinking error. She glared at me as if she had just bitten off a piece of lemon. We have spent Rs 1,000 regardless of whether we stay or leave, so this factor should not play a role in our decision, I said, desperately trying to clarify the situation. Needless to say, I gave up and sank back down in my seat.
Next day, I sat in a marketing meet up to review the advertising campaign that was running for the past four-plus months and had missed its slated goals with a mile. I was in favour of scrapping it which was resisted overwhelmingly by the advertising manager saying – but we have invested so much money in this already and if we stop now, it’s all gone up in smoke, hence let’s carry on. Another victim of the sunk cost fallacy.
A friend struggled for years in a turbulent, violent relationship. His girl cheated on him, many times over and each time she came back repentant and begged for forgiveness. He explained it to me in this way — I have invested so much energy in the relationship, it would be wrong, rude to throw it away. Another classic case of sunk cost fallacy.
Investors fall for this – sunk cost fallacy – often they base their trading decisions on acquisition prices. I lost so much money with this stock, and now I simply cannot sell it now. This is irrational as the acquisition price should play no role. What counts is the stock future performance and the future performance of alternative investments. Ironically the more money a share loses, the more investors tend to stick by it.
This irrational behaviour is driven by the need for consistency. After all, consistency signifies credibility and we all find contradictions abominable. If we decide to cancel a project half way through, we create a contradiction: we admit that we once thought differently. Carrying on with a meaningless project delays this painful relationship and keeps up appearances.
Concorde was a prime example of government’s deficit project. Even though both parties – Britain and France had long known that the supersonic aircraft business would never ever work, they relentless carried on and invested enormous sums of money in it – if only to save face. Abandoning the project would have been tantamount to admitting defeat which is simply unacceptable. The sunk cost fallacy is, therefore, often referred to as the Concorde Effect.
It leads to costly, even disastrous, errors of judgement. The American extended their involvement in the Vietnam War cause of this. Their thinking – we have already scarified so much for this war, and it would be a mistake to give up now.
Of course, there may be good reasons to continue investing in something to finalise it. But beware of doing so for the wrong reasons, such as to justify non – recoverable investments. Rational decision- making requires you to forget about the costs incurred to date. No matter how much you have already invested, only your assessment of the future costs and resultants benefits shall count
Your call now, folks!
The author is an executive coach and mentor, Excalibre