The Sunk Cost Fallacy
This is something everyone should know about. The idea of a “sunk cost” comes from economics. I first learned it in a college econ course about seven years ago. Nowadays, I see it mentioned all the time, but I’m not sure if general knowledge of it has spread or I’m just more prone to noticing something I’m familiar with (that would be an example of availability bias).
A simple explanation of sunk costs is that there are certain kinds of costs that have no way of being recouped or recovered. In these cases, decision theory holds that it’s best to ignore the sunk costs when deciding what future action you should take.
Whether you honor your commitment to previous plans or not, there’s no recovery of your lost time or spent assets. The fallacy that many fall prey to is the gut reaction that changing your plans is a waste of the resources and effort already put towards something.
But the past has happened and can’t be changed. If there’s no way to recover lost value in the present or future, then heading further down a bad path will only waste even more. From the present forward, you should do what is best for you.
Here’s a simple scenario that illustrates why economics students learn about this.
Imagine a business buys a bunch of expensive hardware, and a year later that hardware is obsolete. They can no longer compete in their industry. Their choices are to invest in more hardware or try to carry on with what they’ve got. They decide to keep using what they’ve already bought, because dammit, that stuff was expensive! Does that sound like a sound business plan? Of course not. Just because they spent money on the hardware doesn’t mean they should muddle through using it when it’s bad for their business. That money is sunk.
The same principles apply outside of the business world. Let me give an example from my own life.
I started college majoring in Chemical Engineering. After a few semesters of long, late night chemistry labs, I realized there was almost nothing I hated more than physically doing chemistry. By then I had already racked up many credits that would only be good towards that particular major. Did that mean I should keep going in a major I hated? No. The time I’d spent on it was a sunk cost; I couldn’t get it back. I needed to do what was best for me, and that was switching majors. Making that decision instantly pushed my graduation date back a year, but throwing even more time into something I didn’t want to stick with would have been even worse.
And years later, it was also knowing about the sunk cost fallacy that allowed me to drop out of my Master’s program. I’d accrued $8,000 dollars of grad school tuition debt. This wasn’t an easy thing to swallow. I still had to pay that money back, and honestly, it felt like I was paying for a bunch of nothing since I didn’t finish. But I’d have had to pay it whether I got a master’s degree or not. In fact, if I’d continued attending, the bill would have been astronomically higher. And for reasons relating to the industry I work in, it wouldn’t have been very helpful for my career either.
As James Altucher (who’s really not an authority on anything, but has an awesome way with words) said:
There is a cognitive bias called “committment bias.” We think because we’ve already put time and energy (or money) into something that we have to stick with it. But this is just a mental bias. Say no to it.
Photo credit: Fire by Mike Poresky
