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We’ve all been there. You’ve been pouring money into a doomed project for weeks, months, maybe even years. But you can’t seem to stop yourself. Even though you know it’s a lost cause, you keep throwing good money after bad. Why? Because of the sunk cost fallacy.
What is the sunk cost fallacy?
The sunk cost fallacy is the idea that we are more likely to continue investing in something as long as we have already invested so much time and money into it. Even if it’s clear that the investment is no longer worth it, we can’t help but keep going because we don’t want to see all that time and money go to waste.
Of course, this isn’t rational thinking. Just because you have already invested a lot into something doesn’t mean you should keep investing in it. If anything, you should cut your losses and move on. But our brains don’t work that way. The sunk cost fallacy is a cognitive bias that causes us to make decisions based on emotions instead of logic.
Why do we fall for the sunk cost fallacy?
There are a few reasons why we tend to fall for the sunk cost fallacy. For one thing, humans are loss-averse creatures. We experience more psychological pain from losing $100 than we experience joy from winning $100. This tendency leads us to hold onto losing investments in the hopes that they will eventually turn around and become profitable again.
In addition, the sunk cost fallacy plays into our need for closure. We hate unfinished business and loose ends. So even if we know an investment is a lost cause, we often feel compelled to see it through to the end just so we can put a neat little bow on it and move on.
Finally, the sunk cost fallacy is often perpetuated by confirmation bias. This is the tendency to seek out information that confirms our existing beliefs while ignoring evidence to the contrary. So if we believe an investment is a good idea, we’re more likely to find articles and experts that support our position while disregarding those that don’t.
How to avoid the sunk cost fallacy
The best way to avoid falling for the sunk cost fallacy is to think about future opportunities costs instead of past costs when making investment decisions. In other words, don’t focus on how much you’ve already invested in something—focus on what your next best alternative would be if you pulled out now.
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For example, let’s say you’ve been throwing money into a mutual fund for years even though it has consistently underperformed the market as a whole. You know you should sell now and invest your money elsewhere, but you can’t seem to pull the trigger because of all the time and money you’ve already invested in the fund. Instead of looking at things this way, try to think about what your next best alternative would be if you sold today. If you invest that money in a better performing fund, you could actually come out ahead even though you “lost” money on your original investment!
The sunk cost fallacy is a cognitive bias that causes us to make sub-optimal decisions by focusing on past costs instead of future opportunities costs. By being aware of this bias and thinking about future opportunities costs instead of past costs when making investment decisions, you can avoid falling for the sunk cost fallacy and make better choices with your money!