Abu Dhabi, UAEMonday 16 December 2019

Let sunk costs sink and get on a new boat

Psychologically “losses loom larger than gains,” but that is no reason to make bad decisions causing further damage

Illustration by Gary Clement
Illustration by Gary Clement

“Just because you’ve spent a lot of money on something does not mean you should plough more and more money into it.”

“It was terrible, but we stayed until the end because we paid a lot for the tickets.”

These quotes are about money being spent, and a desired outcome not being achieved. The following quote refers to the ‘human’ way of processing these situations: “losses loom larger than gains” (from a 1979 scholarly paper by psychologists Daniel Kahneman and Amos Tversky).

Sticking with a situation that is draining in any way only serves to make you worse off — perhaps emotionally and mentally as well as financially.

Nima Abu Wardeh

Today we’re delving into the sunk cost effect. Unchecked, it can ruin your decisions.

The first quote is from the UK’s Transport Secretary Grant Shapps who, last week, said an independent review of H2S — Europe’s largest high speed rail infrastructure project — was a "responsible" move to see whether the benefits really "stack up". Brave words, seeing as £7.4 billion has already been spent on it. You can imagine the backlash.

The second quote is my son reporting back on what he did with friends one afternoon — they had gone to see a much anticipated film, spent precious money on tickets and were utterly bored. But they stayed until the end because it would be a ‘waste’ if they walked out.

The sunk cost effect is the tendency we have to continue with an endeavour, or consuming or pursuing an option, if we’ve invested a resource — such as time or money.

Like the uncomfortable, expensive shoes you don’t wear, but keep. The meal you finish even though you’re full because you paid for it. Or that rental property you’re losing money on every month, but won’t sell because you want to recoup the money you spent on a downpayment and renovation.

This effect becomes a fallacy when “it’s pushing you to do things that are making you unhappy or worse off,” according to Christopher Olivola, an assistant professor of marketing at Carnegie Mellon’s Tepper School of Business and the author of a paper on the topic published in the journal Psychological Science last summer.

It’s a tough one, because it means that the plan you painstakingly worked out and worked on is not serving you. It means that what you expect, or believe in, and what you get in reality do not match up. It is confusing for us to deal with.

When it comes to money issues, there can be the added element of guilt if the money ‘wasted’ is not your own. I know spouses who have a huge sense of guilt as a result of decisions they made that led to family savings being wiped out.

Mr Olivola devised a series of experiments to test our behaviour regarding the sunk cost effect. In one, participants were asked to imagine they were mistakenly booked on two trips over the same weekend. One was a fabulous fun one that cost $200, while the other, more expensive at $800, was not as much fun. Guess which most opted for.

The money is gone. The sane way of looking at this is to figure out which destination is your first choice and gives you the most joy. But most people factored in money, not pleasure, and went with the more expensive one — because it was more expensive. Sticking with a situation that is draining in any way only serves to make you worse off — perhaps emotionally and mentally as well as financially.

If it’s about being brave, think about H2S - that huge, expensive, ambitious infrastructure project. The £7.4bn spent is a heck of a lot of money in anyone’s book — but a drop in the ocean compared to the current total budget of £55.6bn, with some saying it could go up by another £30bn.

Knowing when to quit, and when to keep going, is a hard choice. The more time, energy and resources we invest, the harder it becomes to walk away. Plus, it goes against an innate aversion to loss. And, let’s be honest, it’s tough admitting — to yourself first — that you’ve wasted X years of energy, life, money, et cetera.

Willing something to get better doesn’t work. By definition, sunk costs are payments or investments that can never be recovered. In other words, don’t take this cost into account when figuring out your next financial step. It hurts to lose something permanently. Dragging it out will hurt a lot more. Go with whatever gives you a chance of a better future.

Nima Abu Wardeh is a broadcast journalist, columnist and blogger. Share her journey on finding-nima.com

Updated: August 29, 2019 12:44 PM

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