Sunk Cost (Retrospective Cost)
Verb
A cost that has already been incurred and cannot be recovered. [1][2][3][4]
A historic cost that is no longer relevant to decision making regarding the future. [3]
"When you feel you're in too deep or too invested to walk away, therefore continuing to invest despite it logically being the wrong move." - Self-Mastery
When a Sunk Cost is influencing your current decisions, this is called "Sunk Cost Fallacy". For instance, if your justification for pouring more resources into something, whether it be time, money or people, is because you've already invested resources into it, that is Sunk Cost Fallacy. Therefore, a Sunk Cost should never influence your decisions, as you are highly likely to be digging a deeper hole for yourself. You should therefore stop, cut your losses and move on.
"Don't throw good money after bad."
To make things clearer, let's review a well-known example of Sunk Cost Fallacy.
From 1976 to 2003, people looked up to the sky, witnessing a roaring supersonic jet cutting through the sky like a lightning bolt; I am of course referring to the Concord. The Concord was almost a dream to fly in and it got its passengers to their destination in no time. However, was the project worth it? Especially as the cost of the project was initially under $400 million but ended up being $2 billion [17]. Well, the UK and French governments took their already heavy investment (sunk cost) as a justification for continuing the Concorde project, although it was economically unnecessary and posed no advantages. However, the project continued as this would have harsh political repercussions for both parties involved. This is a typical example of Sunk Cost Fallacy and has been notoriously labelled as the "Concord Fallacy". [9]
Crazy right? Why would someone pursue a project that brought no real benefits or value, of which cost over 5 times its original projected cost? All for a loud shiny toy! Although illogical, it is not only large corporations and governments that are guilty of this behaviour. Let's consider the following scenario.
Let's say you bought tickets to see a movie, but within 15 minutes you realised the movie was terrible and knew you were not going to enjoy it. At the present moment in time, you have two options:
Sit through the movie as you feel you need to get your monies worth as walking out of a movie will be a waste of money.
Walk out of the movie which saves you the time you would have spent sitting through the movie that you did not like.
Although most may sit through the movie as walking out will seem like a waste of money, economically, this makes no sense as the ticket has already been bought. So, it is best to cut your losses and leave the movie early which saves you the time that would have been wasted if you sat through it. The former wastes time and money, whereas the latter only wastes money. Either way, the money spent on the ticket (sun cost) is non-retrievable.
This is just one typical example most of us have perhaps faced. Other typical scenarios include staying in relationships much longer than we should have. Just because we've "invested too much to leave" and we're clinging onto the hope that one day things will magically change doesn't justify why we should stay in it. Or when gamblers continue playing at the casino, despite already incurring heavy losses of most or all their money. A common reason for this irrational behaviour is to recover the money the gamblers lost. In a gambler's world, this is called "chasing your losses" [15].
"A good poker player knows when to fold."
Although it's logical to just cut your losses and move on, which is what we should do, it is not as easy as it seems – especially if you're the one in the situation. And this is explained using behavioural economics. When irrational behaviour is scientifically justified, it makes things less personal, and guess what – it isn't personal. And here's why ...
Bygones Principle
This principle states that only future costs are relevant to judicious decision making [6]. Therefore, it is best to make decisions on only what the current situation entails [7]. Forecasting future consequences, and whether they actually occur are what matter, not past mistakes or consequences [8]. Previous consequences are deemed as "water under the bridge", "spilt milk" and "bygones", and therefore called "Bygones Principle" [1].
Plan Continuation Bias
"Plan Continuation Bias" is the forced continuation of an existing plan or action, even in the face of adversity and risk [10].
Let's explore an example of aviation, where a NASA study in 2004 found that 9 out of 19 accidents were due to Plan Continuation Bias [11]. The study concluded that most accidents could have been avoided by not forcing a landing and executing a missed approach. It was noted that aircrews found it difficult to do just that. As the pilots felt too invested, they performed unnecessarily risky manoeuvres to land on their first attempt. In an analysis of 279 approach and landing accidents (ALAs), the fourth most common cause of accidents which made up 11% of all accidents was due to Plan Continuation Bias [13]. Another analysis found that out of 76 accidents it was the cause of 42% of ALAs [14].
A famous example also exists, where a captain of a tanker persisted on a risky course as opposed to not accepting a delay. This incident called the "Torrey Canyon Oil Spill" resulted in a spill of 25-36 million gallons of crude oil [12].
In our lives, we may have also suffered the consequences of Plan Continuation Bias. For instance, holding onto a stock for too long in the hope of it bouncing back up – when previous performance is only indicative and does not guarantee the stocks recovery. Or how about speeding up in order to get through an amber traffic light? Sometimes it may even go red, but as we have committed to a plan of action, we end up accelerating through, despite our mind telling us it's the wrong thing to do.
Politicians also fall victim to this, as political u-turn can make the government in power seem weak, incompetent and untrustworthy. This, therefore, leads to countries pouring millions or even billions into projects that are no longer feasible. A typical example of this is the High Speed 2 Rail (HS2) that has resulted in an overspend of £50 billion [16].
Traders in banks use the concept of cutting their losses by using what is referred to as a "Stop Loss" [18]. For instance, if a traded stock decreases in value by a certain amount, the stock is sold. Although this results in a guaranteed loss, the loss is minimised to an agreed amount. This is sensible as commitments are intelligently made beforehand, removing emotion which results in safer operations.
"Cut your losses and let your profits run." - American Proverb
Isn't it fascinating how a branch of science called behavioural economics can scientifically explain the irrational decisions made by people, of which have not only resulted in huge financial losses but the loss of life and heavy environmental damage too? But why am I giving you a lesson in behavioural economics and how does it apply to you? A fair question, and here is why this information can result in us bettering our lives with the simple concept of cutting our losses.
"Imagine this: If you had £86,400 in an account and someone stole £10 from you, would you be upset and throw all of the remaining £86,390 away in the hope of getting back at the person who took your £10? Or move on and live? Right, move on and live. See, we have 86,400 seconds each day. Don’t let someone’s negative 10 seconds ruin the remaining 86,390. Don’t sweat the small stuff. Life is bigger than that."
How many times have we let the actions of others or the consequences of a mistake we made many moons ago torture us years or even decades later? If so, we have obviously made the same mistake by allowing the Sunk Cost, which is the initial event to dictate our decisions going forward. This not only turns our days and nights into a hellish turmoil but results in poor health and well being. We then overpay for the grudges we cherish with our peace of mind. Why not do what traders do and put a stop loss on your worries, anxieties, bitterness, anger and bad mood? Why not, instead of suffering a crash – abort the landing and move on safely? Why not cut your losses earlier on, so you no longer keep paying for something that has been done and dusted?
"If you have made a mistake cut your losses as quickly as possible." - Bernard Baruch
"To forgive is to set a prisoner free and discover that the prisoner was you." - Lewis B. Smedes
If human nature is so strong that pilots can cause fatal air crashes, millions of gallons of oil could spill out of tankers and seriously harm the planet, billions of pounds are wasted on projects and millions of lives are put at risk due to governments not willing to take a U-turn on policies, you cannot blame yourself for not being able to naturally cut your losses and move on. However, dwelling on negatives experiences or emotions is just as bad, if not worse. We must recognise this is highly unintelligent and actually causes graver harm, as opposed to simply cutting our losses and moving on. It's highly beneficial to evaluate how much bother a situation is worth and move on from it.
"The cost of a thing is the amount of what I will call life which is required to be exchanged for it, immediately or in the long run.” - Henry David Thoreau
"If something costs you peace of mind it might be too expensive." - Big Sean
Key takeaway: Whenever you are tempted to get yourself out of a hole by digging deeper, go through and answer the below questions:
What has upset you? (Concretely write down what has happened to invoke emotions of worry, anxiety, fear, anger, frustration, hopelessness, despair or rebellion.)
How much influence does this loss have on your future? Is it worth preserving this loss as a life sentence?
Is it worth overpaying for this loss by allocating it more resources such as time, money, happiness, joy, mental energy, emotional balance, physical health and spiritual growth? Will negative health consequences repay this loss?
Are you overexaggerating your losses? (We all get a short few decades to live and have ups and downs. Any over-exaggeration is paid by us dearly – we pay for them with our peace of mind.)
How much more should you pay for this until you totally cut your losses and move on freehanded? Is it worth walking through the path of life with a bag full of dead rocks?
What will you gain and lose if you stick to this way of thinking? What will you gain and lose if you cut your losses and move on from this frame of mind?
Would your life be different, at least mentally, if you always cut your losses straight after a loss and move on immediately?
References
Wikipedia - Sunk cost: https://en.wikipedia.org/wiki/Sunk_cost
Mankiw, N. Gregory (2009). Principles of Microeconomics (5th ed.). Mason, OH: Cengage Learning. pp. 296–297. ISBN 978-1-111-80697-2.
Mankiw, N. Gregory (2018). Principles of Economics (8th ed.). Boston, MA: Cengage Learning. pp. 274–276. ISBN 978-1-305-58512-6.
Hussain, Tahir (2010). Engineering Economics. New Delhi: Laxmi Publications, Ltd. ISBN 978-93-80386-47-8.
Wikipedia - Concorde: https://en.wikipedia.org/wiki/Concorde
Sharma, Sanjay; Sharma, Pramodita (2019). Patient Capital. Cambridge University Press. ISBN 978-1-107-12366-3.
Lipsey, Richard G.; Harbury, Colin (1992). First Principles of Economics. Oxford University Press. p. 143. ISBN978-0-297-82120-5.
Ryan, Bob (2004). Finance and Accounting for Business. Cengage Learning EMEA. pp. 229–230. ISBN978-1-86152-993-0.
Weatherhead, P.J. (1979). "Do Savannah Sparrows Commit the Concorde Fallacy?". Behav. Ecol. Sociobiol. Springer Berlin.
Flying in the rear view mirror: https://criticaluncertainties.com/2011/06/26/flying-in-the-rear-view-mirror
Nasa Study: https://human-factors.arc.nasa.gov/flightcognition/article2.htm
Torrey Canyon oil spill: https://en.wikipedia.org/wiki/Torrey_Canyon_oil_spill
Khatwa, Ratan; Helmreich, Robert (November 1998 – February 1999), "Analysis of Critical Factors During Approach and Landing in Accidents and Normal Flight" (PDF), Flight Safety Digest, pp. 1–77
Bermin, Benjamin A.; Dismukes, R. Key (December 2006), "Pressing the Approach" (PDF), Aviation Safety World, pp. 28–33
The trick to learning when to cut your losses: https://www.bbc.com/worklife/article/20180914-the-trick-to-learning-when-to-cut-your-losses
HS2: When will the line open and how much will it cost?: https://www.bbc.co.uk/news/uk-16473296
CONCORDE'S COST NOW AT $2‐BILLION: https://www.nytimes.com/1971/03/04/archives/concordes-cost-now-at-2billion-airline-project-is-under-new-attack.html
Stop - Loss Order: https://www.investopedia.com/terms/s/stop-lossorder.asp
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