The Sunk Cost Fallacy

By Anesu Gwatidzo

From an economics and business decision-making point of view, a sunk cost is a cost that has already been incurred and can no longer be recovered. Sunk costs are contrasted with forthcoming costs which are essentially future costs that may be avoided if action is taken beforehand. 

The misconception: You make rational decisions based on the future value of objects, investments and experiences.

The truth: Your decisions are tainted by the emotional investments you accumulate and the more you invest in something the harder it becomes to abandon it.

Take the lottery for example. Millions of people play the game every day with the hope of doubling their returns. So you would ideally assume it is a game that will bring players insurmountable joy right? The appeal of the lottery has little to do with enjoyment. What spurs people on is the idea of averting some loss to make a considerable gain. The loss being the few dollars you spend on a ticket and the gain being the ability to win thousands more. Our loss aversion system is always aware, waiting on an opportunity to keep you from giving up more than you can afford to spare so you calculate the balance between the cost of the purchase and the reward of the purchase whenever possible. So what keeps people playing the game is the emotional investment that comes with believing that on the next draw when those 8 numbers roll down your screen you could wake up a millionaire. The more you play and have an occasional winner win, the more you believe you can win.

The fear of loss predominantly leads to the sunk cost fallacy. What we see with our case in Zimbabwe because of the 2008 economic collapse, and seeing the economy somewhat struggle for the following 12 years to recover is a clear case of this. When we talk about investing or even think about investing the conversation is almost full circle and comes back to one conclusive deduction, ”I do not want to lose my money again as I did years ago. We have done this before.”

The key thing in decision making is committing to a decision that will benefit you in the long run? So why do something more than once if more times the result will go against your best interests? Taking the United States of America as an example, there have been six major market collapses recorded where the stock market has lost over 10% of its value. However, in those 6 major market collapses there have been big winners and big losers who have emerged on the other side of these shifts in the markets. What this shows is there is some upside in every situation. The key is finding it.

Ultimately, the decision we face is between time and cost. The worst thing about time is that it cannot be bought back. The thing I find most interesting is the outcomes in success when investing. There are almost always two constants. Time and cost. Firstly, what it will cost you for either making a bad decision or alternatively a good decision. The second being when you decided to make that decision. See the trap is that because of human nature we believe our past experiences directly affect our present future. That is primarily true as history has shown to repeat itself in most cases, however, most people tend to focus on the downside of historical events as opposed to the silver lining.

So if there is a silver lining and you can see it why are you letting past experiences cloud your judgement. If you cannot see it you probably have not found the right person to assist you in the correct way and you probably should because again the only thing that cannot be bought back is time. Costs that have already been incurred by past actions cannot be recovered. They are not relevant to future decisions. Progress is key. Make smart decisions and invest wisely.

Anesu Gwatidzo is a Business Development Specialist at Carrick Wealth which is a dynamic and independent financial services provider specialising in integrated wealth management. You can connect with Anesu here: LinkedIn

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