“I’ve invested too much, to give up now”. “We’ve put a lot of money into this, we can just abandon the whole project”. That’s how the sunk cost effect sounds like in real life. It’s the opposite of abandoning a wrong path, no matter how far you’ve went down that road.

The sunk cost effect or the sunk cost fallacy is an error in reasoning that makes it difficult for people to abandon something they’ve put a lot of effort into. It’s the hidden “force” that pumps money into bleeding projects, that makes us go on vacation even if we’re sick, because we’ve been planning It for a long time and spent money and research time on it.

Let’s rephrase the definition of the sunk cost effect one more time: it means continuing to invest into something that clearly doesn’t work.  That can be a career path, a relationship, even a goal.

What causes the sunk cost effect?

The number one cause behind the sunk cost effect is loss aversion. Generally, people refuse to accept a loss. The pain of losing is 2x stronger than the joy of winning. It’s one of the factors that keeps us in relationships which are no longer working. It’s hard to accept that after all the time and energy invested, it’s a loss.

A second factor is the initial commitment trap – discussed in detail here. Just because at some point you’ve made a decision, you don’t have to stick to it, if the context has changed. And even if it hasn’t changed, maybe your goals or objectives have changed.

Emotional perception is a third cause. That can be either emotional attachment through time and energy invested or a lack of ownership. Admitting the reality of a poor investment might make you look bad or incompetent.

Sometimes sunk cost is prevention cost. An insurance is a sunk cost, unless the insured risk takes place and you get to benefit from the insurance. But don’t think about insurance policies alone. A prevention cost could be something you do as due diligence, like investigating several holiday destinations, although you will only pick one.

Studies of the sunk cost date back to 1985 thanks to Dr Hal Arkes and Catherine Blumer. One experiment revealed that we are likely to give up a more positive experience in favour of another one that has incurred a higher (sunk) cost. Let that sink in for a while.

ELI5 – Examples of the sunk cost effect

An investment in analysis or design is a sunk cost. Whether or not you will you use the design or the results of the analysis, that money has been spent.

The groceries you buy are normally a sunk cost, as you don’t expect to resell them.

A show ticket that you buy, assuming the cost cannot be recovered and the ticket cannot be transferred (and potentially get some money back) is a sunk cost. Whether you will attend the show or not, the money has been spent.

In management, the sunk cost fallacy prevents managers from changing decisions, although it’s obvious the initial plan is no longer feasible. In investments, the same effect prevents people from stopping an investment that proved to be a disaster.

How can you control this effect?

Accept risks. One of the first things stock market investors learn (if they do study a bit) is that a winning strategy is one that brings profit 60-70% of the time. It’s not infallible and loss is unavoidable.

Look at the facts. You’ve spent an amount of resources (time, physical energy, money). What results do you have? Don’t come up with explanations at this point. We’re not trying to justify anything. What results do you have? Be objective. What guarantees do you have that if you keep investing, results will be different? What has changed?

Can you use the sunk cost effect to your benefit?

If you understand it, yes.

Sunk cost makes sense in research or in a discovery process. When you are trying to solve a problem from different angles and you have no guarantee or prior knowledge as to what will actually work. You accept the cost as an investment and it will not tie you to further spending.

To bring down the loss aversion you need to see the full half of the cup. What have you learned from this loss of resources? What was your experience gain? Reframing the story in this way will help you stop perceiving the sunk cost as a loss. It might’ve been an expensive lesson or a painful one. So what? In economy, only future costs are relevant for future decisions.

In marketing, this effect is used in up-selling. Once you’re ready to checkout, a message pops-up: for only 10 EUR you can add also this discounted item. Well, what the heck, you’ve spent so much already, what difference will another 10 EUR make, right? Until you add up everything…

Understanding the sunk cost effect can prevent you from pursuing a career that you hate, just because you’ve already studied it for x years. With better choices, comes a better life.

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