The Secret to Eliminating the Sunk Cost Fallacy: Have you ever found yourself in a situation where you went to the cinema to watch a movie, expecting it to be great, but it turned out to be terrible? What did you do next? Did you walk out of the theater because you were afraid you had already paid for the ticket, or did you stay until the end? If you chose the latter, you have fallen for the sunk cost fallacy.

What is a Sunk Cost?

A sunk cost refers to costs that have already been incurred and are irrecoverable. Here, the cost can be your money, time, or any other resources.

For example, suppose you bought a brand-new machine. However, after using it for three months, you realized that the machine did not work as you had expected. Clearly, the payback period for this machine has already passed. Here, even if you sell the machine, you will receive a depreciated value compared to what you initially purchased. This cost is called a sunk cost.

Generally, people should not consider sunk costs when making decisions because these costs are irrelevant to anything that happens in the future. However, humans are emotional beings, and unlike robots, we do not always make rational decisions.

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Examples of the Sunk Cost Fallacy

This mistake is called the "cost of sinking," where an individual pays a price for making a sinking decision.

We have already discussed an example of watching an entire movie (even if it's terrible) simply because, as a consumer, you won't get your money back for the ticket. This is a classic example of the sunk cost fallacy.

Another example is when you eat food you don't like because you have already bought it and cannot recover the sunk cost. Similarly, overeating after ordering at a restaurant is also an example of the sunk cost fallacy.Additionally, a classic example of the same fallacy is when you continue to take those poor courses in college (that you dislike) because you have already invested a lot of time in them, and you have also paid tuition fees. Furthermore, wages, loans, etc., are also considered sunk costs because you cannot prevent these costs.

It should be mentioned that not all past costs are sunk costs. For instance, suppose you bought a pair of shoes and did not like them once you got home. However, since the shoes are still within the 30-day return period, you can return them here and recover your purchase price. This is not a case of a "sunk cost."

The Sunk Cost Dilemma

The sunk cost dilemma is an emotional difficulty where you have already spent a significant amount of money and time (i.e., sunk costs) on a project/transaction, and the dilemma is whether to continue with it or to withdraw because the expected results have not been achieved, or because the project's prospects are uncertain.

Here, the dilemma is that the person cannot easily leave the project because they have already invested a lot of time and effort. On the other hand, continuously pouring more money, time, and resources into the project does not seem like a good idea either, as the outcome is uncertain. This decision-making predicament of whether to move forward or withdraw is called the sunk cost dilemma.

For example, suppose you started a business and have invested 200,000 yuan over the past three years. However, so far, you have not achieved any desired results. Moreover, you do not see the business developing in the future. Here, the dilemma is "what to do next?" Should you bear the loss and continue, or should you invest more resources in an uncertain business?

Another common example of the sunk cost dilemma is a bad marriage. Here, couples find it difficult to decide whether to save themselves (and their spouses) by breaking up because they are convinced that things will not work out. Or should they persist in the marriage simply because they have spent a lot of time together, and breaking up would make them look bad?

The Sunk Cost Dilemma in Investing

Even investors, being ordinary people, face the sunk cost dilemma when making investment decisions.

For instance, suppose an investor buys a stock at 100 yuan. Later, the stock's price begins to fall. To minimize losses, the investor buys more shares as the stock price continues to drop, thereby calculating the average purchase price. Here, a dilemma arises when the stock has performed poorly over a long period. The uncertainty lies in whether the investor hopes to recoup the loss through the paper loss or should they cut their losses and sell.Another example of the sunk cost fallacy is when individuals, having suffered significant losses in the past and thus "breaking even," proceed to heavily buy or sell high-risk stocks. However, these losses have already occurred, and investing in high-risk stocks to recoup them offers no benefit to these investors.

A better approach is to select stocks that are likely to yield the best returns in the future, rather than the imagined aggressive returns they expect to match their sunk costs. As a savvy investor, one should not consider sunk costs when making decisions. Yet, this rarely happens.

In summary, it is undeniable that no one likes to fail, and thus past losses can influence an individual's future decisions. However, when making decisions, one must not take into account their investment costs.

Since sunk costs are unchangeable (recoverable), rational individuals should disregard them when making judgments. Here, if you want to proceed, first, you should logically assess whether the project/transaction is beneficial for the future. If not, halt the project. In other words, try to predict the future and react accordingly.

In any case, several methods to address the sunk cost dilemma are: choosing options with a higher probability of incremental wins, increasing your options (not just completely giving up or going all in), and in the ultimate scenario, reducing your losses. When caught in this predicament, try to minimize losses by seeking ways to mitigate them.