Don't Fall into the Sunk Cost Trap

A company invested millions of dollars into developing a new software product. Despite numerous signs that the project is not viable and market demand is lacking, the team decides to continue to invest more money and resources, hoping to turn things around.

An investor buys shares in a company, and the stock's value plummets due to poor performance and negative news. Instead of selling the shares and cutting losses, the investor holds onto the stock, unwilling to realize the loss and hoping it will recover, even though the company's outlook remains bleak.

Your friend is in a long-term relationship that has become increasingly unhappy and unfulfilling. They continue the relationship because they have already invested several years into it, even though they have both been miserable for some time.

These are all classic examples of the sunk cost fallacy.

The sunk cost fallacy is a cognitive bias that leads us to continue investing in a decision, relationship or project based on the cumulative prior investment (time, money, resources) despite new evidence suggesting that the cost, moving forward, outweighs the benefits. This fallacy occurs because the sunk costs—costs that have already been incurred and cannot be recovered—are irrationally considered when making future decisions, even though these costs should be irrelevant.

Perhaps the most famous example of the sunk cost fallacy was coined the Concorde fallacy. The Concorde was a joint project between the British and French governments in the 1960s and 1970s to develop a supersonic passenger jet that could travel from New York to London in half the normal time, clocking 1,350 miles per hour. The Concorde was estimated to cost almost $100 million. Despite numerous economic and environmental challenges, including high development costs, limited market demand, and emerging competition, the project continued.

In 1971, the British government received this memorandum warning them that the project was a poor investment:

Concorde is a commercial disaster. It should never have been started. On 30 November 1971, it had cost the British Government an irrecoverable £350 million. If continued, development and production will cost us at least £475 million more (£392 million present value) from 1971–75. Concorde will make little money for its manufacturers and precious little, if anything, for the airlines who buy it. The total liability to the United Kingdom alone could be about £550 million excluding the written off £350 million mentioned above.

... The decision whether or not to abandon Concorde must start from where we are now—much of the milk is already spilt.

(Central Policy Review Staff, 1971, p.1)

There were a multitude of factors that led to Concorde's retirement in 2003– both commercial and safety-related. But the history behind it highlights the dangers of letting past investments dictate future decisions.

3 Psychological Factors that prime us for the

Sunk Cost Trap

Loss Aversion: People work harder to avoid a loss than they do to achieve a reward.

Loss aversion is a concept from behavioral economics that explains how the emotional impact of losing something can be twice as powerful as the pleasure of gaining something of equal value. For instance, losing $100 feels more distressing than the joy felt from gaining $100.

Cognitive Dissonance: People feel uncomfortable when their beliefs and actions are contradictory.

The inconsistency between what people believe and how they behave motivates them to engage in actions that will help minimize feelings of discomfort. People try to relieve this discomfort in different ways, such as by rejecting or avoiding new information or justifying or rationalizing decisions.

Cost of Reward: The more you put into something, the more you hope to get out of it.  

The brain releases more dopamine — the reward and pleasure chemical — when a reward is harder to achieve. Because dopamine is also the learning/motivation chemical, it reinforces past behaviors. We often make decisions based on previous investments, even if the probability of actually gaining an objective advantage from it is zero.