Have you ever made a decision to continue with a course of action based on what you’ve already put into it? This bias, known as “sunk cost fallacy”, might mean you don’t make rational decisions and stick to a path that’s no longer right for you.
If you’ve been affected by the sunk cost fallacy, it doesn’t automatically mean you made a wrong decision. In fact, factors outside of your control could mean that what was once an excellent decision for you, no longer makes sense. However, by basing your next decision on what you’ve already done, you could hinder your ability to make the “right” choice now.
Feeling like you’ve already invested resources may mean you don’t want to turn away
The sunk cost fallacy refers to the resources you’ve lost and can’t get back. This loss might mean you’re less likely to assess alternative options, as you don’t want it to be in vain.
So, your past effort affects the decisions you’re making about the future.
The sunk cost fallacy is more likely to occur if you’ve already invested heavily in something. It doesn’t have to be a financial investment. The time you’ve poured into a project or the emotional energy you’ve dedicated to it could cloud your judgement too.
It’s often linked to other types of cognitive bias.
For example, loss aversion theory suggests you feel emotions connected with loss more keenly than those associated with winning. So, if you feel like you’ve lost resources, you might be more emotional, and less likely to focus on logic than you usually would.
Another bias sunk cost fallacy is often linked to is confirmation bias – where you seek out information that supports your preconceived idea. If you’ve already decided you want to proceed with a plan because you’ve invested in it already, you might start to prioritise data that suggests this is the right thing to do.
There are plenty of examples of the way sunk cost fallacy might affect you.
If you’re taking the lead on a project at work, you might be reluctant to change course, even if it’s clear it isn’t going to work as well as alternatives, because of the time you’ve already invested.
With your finances, you might refrain from selling an investment that no longer aligns with your financial plan because the share price has fallen recently so you feel like you’ll be “losing”.
4 useful steps that could help you avoid sunk costs affecting your decisions
1. Imagine it’s a new decision
While it’s difficult, try to look at the decision with a fresh perspective – if you hadn’t already sunk costs, how would you view the decision today?
Doing this could highlight where your past efforts might be influencing the decisions you’re making now.
2. Focus on the future
When you’re reassessing your decisions, look forward as well. For example, if you’re reviewing an investment, what are the expected returns and how much risk would you be taking? Looking forward, rather than back, could help focus your mind so you’re not dwelling on perceived losses.
3. Set goals
One effective way of avoiding the sunk cost fallacy is to set goals from the start. If you have a clear idea about what you want to achieve, you’re more likely to be able to evaluate whether sticking to a plan continues to be the right decision.
Taking an objective-based approach means you’re less likely to focus on the emotional side of decision-making, and, instead, pay attention to the expected outcomes. Understanding how decisions might support long-term goals could mean you feel more confident when the evidence suggests a different course of action could be better suited to you.
4. Get an outside view
Sometimes it’s impossible to look at a decision you’ve made objectively, as you may be emotionally attached to it. This is where an outside perspective could be useful.
A person who isn’t thinking about the “losses” could help you see why you’re holding on to a decision that might no longer be right for you.
As a financial planner, we could act as an alternative perspective when you’re assessing financial decisions. If you’d like to talk to us, please get in touch.
Please note: This blog is for general information only and does not constitute financial advice, which should be based on your individual circumstances. The information is aimed at retail clients only.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.
