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May 17, 2017Sunk Cost Fallacy (The Psychology of Money Series*)
In Economics sunk cost is defined as the cost already incurred and cannot be retrieved or recovered.
Rationally, we should make decisions based on the future value of investments, goods, services, and other choices in life. Well, that’s true for the “Econ” (the term used by Richard Thaler to refer to the rational individual always maximizing utility and minimizing costs in traditional Economic theories).
But the human consumer is far from that. Our decisions are tainted with the emotional investments made in costs already incurred, regardless of what the current and future costs and benefits are.
Because we have already put in something that cannot be retrieved anymore, we put more weight on it and stick with the original choice, consequently, foregoing other better options; hence, a fallacy or unsound decision.
This mistake in reasoning is related to the loss aversion principle we discussed in previous articles (Click Loss Aversion and Myopic Loss Aversion to read said articles.) We stick to a previous choice made despite its inferiority because abandoning it is actualizing the loss on this investment. Remember, the impact of a loss is twice as much as that of a gain; hence, we would avoid the loss even if it means foregoing the better prospect of switching to a new choice. We get stuck. In the vernacular, “Hindi maka-move on!”
Let’s take a look at some examples.
In Economics sunk cost is defined as the cost already incurred and cannot be retrieved or recovered.
Rationally, we should make decisions based on the future value of investments, goods, services, and other choices in life. Well, that’s true for the “Econ” (the term used by Richard Thaler to refer to the rational individual always maximizing utility and minimizing costs in traditional Economic theories).
But the human consumer is far from that. Our decisions are tainted with the emotional investments made in costs already incurred, regardless of what the current and future costs and benefits are.
Because we have already put in something that cannot be retrieved anymore, we put more weight on it and stick with the original choice, consequently, foregoing other better options; hence, a fallacy or unsound decision.
This mistake in reasoning is related to the loss aversion principle we discussed in previous articles (Click Loss Aversion and Myopic Loss Aversion to read said articles.) We stick to a previous choice made despite its inferiority because abandoning it is actualizing the loss on this investment. Remember, the impact of a loss is twice as much as that of a gain; hence, we would avoid the loss even if it means foregoing the better prospect of switching to a new choice. We get stuck. In the vernacular, “Hindi maka-move on!”
Let’s take a look at some examples.
The Concorde Effect
An example of sunk cost fallacy in epic proportions is the Concorde. In 1954 a committee was formed to study the supersonic transport concept. Originally formed among British aircraft and engine manufacturers and the government, France joined in 1962. The first supersonic airliner was already predicted to be a failure early on. By the time it made its first commercial flight on January 21, 1976, the enterprise was already plagued with prohibitive cost overruns but everyone involved kept going.
Reasons or justifications used to go on with the project were to provide employment, to maintain technological expertise, etc., but it was primarily the shared psychological burden outweighing any rational judgment that kept the proponents going. They had already put in considerable time, effort and money (a lot of it was British and French taxpayers’ money) that they could not give up. It was only after decades when they finally threw in the towel with the last Concorde flight on October 24, 2003. They spent a total of 1.3 billion pounds sterling.
With this (mis)adventure, the term Concorde effect or Concorde fallacy was coined to refer to the escalation of commitment resulting in an investment trap which is essentially throwing good money after bad.
Farmville knows it
The developers of the online game Farmville know how to trigger the human addiction to investment due to sunk cost fallacy and loss aversion. Farmville is free. The first time you try you are transported to a world of farmlands where you are enticed to plant. You wait, then you will see the fruits of your effort – harvests, coins, etc. Unlike other games wherein you can just start where you left off, this one isn’t so. If you fail to return after a certain period of time, your investments will die! You won’t do that because you don’t want to waste the time, money and effort that you’ve already put in. But wait! There’s a way to stave off these negative feeling of losing, you can pay Farmville real money or participate in the offers of its advertisers.
Some Farmville players even set alarms to wake up at certain times of the day just so their investments won’t die. I’ve heard some complaining, “Bwisit! Napupuyat ako sa Farmville na ‘yan!” (“Grr… I’m losing sleep over this Farmville!”). You can never get back the time and other resources wasted so you keep going. Somehow, you’re not playing to have fun anymore, but to avoid the negative emotions of losing.
The danger of sunk cost fallacy
The sleepless nights caused by Farmville might not be as dangerous but imagine the harm that sunk cost fallacy can do to us. The individual examples enumerated above such as hopeless relationships, poor investments, getting fat, wasting time, stuck in a career, etc. can ruin our life.
Moreover, sunk cost fallacy by our leaders and decision makers can affect whole nations and the entire wolrd. The Concorde effect took a big toll on British and French taxpayers’ money. Sunk cost fallacy makes our leaders do irrational things such as go to war or continue being at war, keep failed policies and projects alive. Go through history and current events, they are happening all over.
Sunk Cost Fallacy vs. Perseverance/Tenacity
So do we give up on our course, career, marriage, stocks, book, movie, project, etc. right away? Don’t we always hear that success stories are made up of perseverance, of not giving up?
Yes. But being aware of this B.E. principle makes us pause and evaluate and ask ourselves the question, “Why am I doing this again?”
The difference between healthy tenacity and sunk cost fallacy lies on how you would answer the question, “If I were to make that decision now, would I still make the same decision?” If your answer is yes, then by all means persevere at it; otherwise, it’s time to move on.
Whether in your investments or other aspects of life, avoid sunk cost fallacy by remembering this:
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*The Psychology of Money Series – Feel free to check Author Archive for previous installments on this series (The Pain of Paying, Mental Accounting, What is the Price We Pay for Free?, Anchoring Effect, Ego Depletion, Loss Aversion, Myopic Loss Aversion etc.)
ANNOUNCEMENTS
1. My special guest for tomorrow on FQ Live! is no other than WILSON SY, known as the Warren Buffett of the Philippines. He will help us in the discussion of Sunk Cost Fallacy. PM us your questions now
2. Want to know your FQ Score. Take it today. Click link to take the test.
3.I will speak at the “12th Puregold-Tindahan ni Aling Puring Sari-sari Store Convention” with the theme #PanalongPagbabago to be held on May 25, 2017 (Thursday), 1:30-2:30pm at the World Trade Center, Manila. My topic is “Pagbabago sa Pananaw sa Pera.” Here are the other speakers.
Rose Fres Fausto is a speaker and author of bestselling books Raising Pinoy Boys and The Retelling of The Richest Man in Babylon (English and Filipino versions). Click this link to read samples – Books of FQ Mom Rose Fres Fausto. She is a Behavioral Economist, Certified Gallup Strengths Coach and the grand prize winner of the first Sinag Financial Literacy Digital Journalism Awards. Follow her on Facebook and You Tube as FQ Mom, and Twitter & Instagram as theFQMom.
ATTRIBUTIONS: Images from 1001 Crash, Clipart Net, ClipartFest, Google Play, HF Plumbing & Heating, OnlyGFX.com, PNG Mart, www.prweek.com and YouTube put together to help deliver the message.
Discussions on Concorde from:
http://leepublish.typepad.com/strategicthinking/2015/03/sunk-cost-fallacy.html, wikipedia
Discussions on Farmville from:
https://youarenotsosmart.com/2011/03/25/the-sunk-cost-fallacy/
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Dec 16, 2019 / 02:10 amEconomic sunk and some of investment related choices and rational to be given for this post. The article is getting great manner of traditional economic theories and original choice of points also. The discussing articles and stuck better concept of choices also. The actual investments and options are ordered with throwing good and money related transactions. The bloated exclusive relationship and wedding preparation methods are entered in this page. The article is getting cost about insurance and also proper investments opportunities also. https://123gst.com/gst-returns-filing/gst-impact-on-manufacturing-business
Sep 01, 2018 / 12:36 pmEconomic sunk and some of investment related choices and rational to be given for this post. The article is getting great manner of traditional economic theories and original choice of points also. The discussing articles and stuck better concept of choices also. The actual investments and options are ordered with throwing good and money related transactions. The bloated exclusive relationship and wedding preparation methods are entered in this page. The article is getting cost about insurance and also proper investments opportunities also. https://123gst.com/gst-returns-filing/gst-impact-on-manufacturing-business
Sep 01, 2018 / 12:36 pmTo start a topic thread and ask the Raising Pinoy Boys community a question, please Sign Up.
To Ask Rose or Her Boys a question go to the Ask Question Page.
Hi, it's on the right hand side under Chapter 6, go there and look for the link: http://www.raisingpinoyboys.com/book/chapter/NgRPBRPB/Q0hBUFRFUiA2IC0gTU9ORVkgTUFUVEVSUyAoT3VyIFNvbidzIEZRKQRPBRPB
Hi Ghurl Vacaro. I hope you read my article that tackled your question. I'm happy to inform you that it received a lot of hits both in this website and PhilStar.com. It was also shared many times. This means that your question helped enlighten a lot of people. Here's the link: http://www.raisingpinoyboys.com/dashboard/showArticle/MTYy
It would be ideal if she were but it's not something we would really "require" so to speak because it's not very common. I guess as long as she's not too much of the "magastos" type because financial literacy is something that you could learn.
@Guest Aug 30, 2011. The title is Raising Pinoy Boys because it's a compilation of a mother raising her Pinoy sons. Yes it's culture specific and middle class because that's where I belong. In my over 2 decades of parenting I have always learned a lot from specific stories of book authors, parenting seminar speakers and even conversations with other parents and educators of boys. Thus, I thought it would be worthwhile to share my specific stories and those of the parents of the successful Pinoy men I featured in the book. Thank you very much for your question.
@Guest Aug 10, 2011 - Yes you may. I would be glad to. Just send me an email specifying your needs for the talk - the audience, the topic, etc. You may send your email to RaisingPinoyBoys@yahoo.com or through this website. Be sure to leave your name and email address. Thank you.
I first heard of Chris Tiu when he became a UAAP basketball player of the Ateneo team. I learned about his other admirable traits later on and decided to include him in the book. Fortunately, his mom is a friend of my co-parent so I was able to interview her. He and his parents attended the book launch (see pics in a previous article on the book launch - Jan 2011).
To ask the Community a question go to Topics page. You have to be a Signed up member of the community to start a topic thread. ( Sign Up )