Contemplating Change and Sunk Costs

The phenomenon of the “sunk-cost” bias or fallacy is often discussed in the context of investing behaviors to refer to a mindset where we hang on to a perpetually under-performing investment as a result of our attachment to and focus upon the amount we paid for it. Our brain instinctively focuses not on the stock’s objective performance over time, but instead anchors the perception of value around the amount originally paid for the investment. If we ignore this bias, we will often wreak havoc on our portfolio performance and thus our long-term financial plans. This sunk-cost bias is one of the more broadly applicable cognitive biases, and this way of thinking can impact many different aspects of our lives, from relationships to careers to what we eat and wear. As we come to the conclusion of another year, it can be helpful to consider the ways that we may be holding on to sunk costs that are adversely impacting our ability to be successful in the future in any number of areas.

Here’s a quote that will help set the stage: “Smart people often get stuck with poor decisions that they keep holding onto hoping that they will prove worthwhile in the long-term.” Let’s explore how this plays out by considering an example outside the world of investing. Unless you are a hard-core minimalist, you more than likely have some piece of clothing in your closet that you bought but have never worn. That shirt, as an example, cost you $100 eighteen months ago. While you haven’t worn it since you bought it, you just KNOW you’re going to have a need for it in the future. And because you spent so much for it, you cannot bring yourself to admit the mistake and part with it now. As it continues to gather dust in your closet, each time you see it, you’re reminded (a) that you have never worn it, and (b) you wrestle, even briefly, with the question of whether you’re going to hold on to it. You may have even dropped it into a donate pile a couple of times, or thought about selling it in on a Facebook group. But the sunk costs haunt you. To dispose of the shirt and free yourself from its psychological burden would be an express admission of a $100 mistake. An unforced error. So the $100 in sunk cost is too high to let it go.

So that shirt in your closet keeps costing you cognitive and emotional resources. The shirt has been paid for. You can’t change that fact. But you can make a new choice today about how much it’s going to cost you moving forward.

In a recent study on the topic, a researcher examined what would happen if participants were forced to make a decision about two trips they were double-booked for: one trip to Montreal, and one to Cancun. Imagine that you had purchased tickets to both locations. After the researchers shared how much the trips costs ($200 and $800, applied to each location in different scenarios), the participants in the study chose the more expensive trip, even if it wasn’t where they wanted to go. Both tickets–the $1000 total cost–had already been paid for and could not be refunded. The total amount was a stone-cold sunk cost. But nevertheless the participants tended to choose the less desirable, more expensive option. Simply because the sunk cost was higher.

Small-scale consumption decisions like clothing and accessories around the home are among the more innocuous examples. But for many of us the sunk-cost trap snares us in ways that are much more impactful, and can have adverse long-term effects on our plans and goals for our lives.

A while back Seth Godin discussed the concept of sunk costs on his Akimbo podcast. He discussed how we often hold on to a philosophy, project, job, career, or business because of all the time, effort, blood, sweat, and tears that went into getting us to where we are today. He rightly reminds us that those sunk costs cannot be retrieved, and instructs that we should essentially view our current state as a “gift” from our prior self that we are free to either accept or reject. If a friend (or your prior self) were to offer you a gift of a pet iguana, you might wisely (but politely) decline the gift on the basis of the knowledge of what it will cost you in the future.

Beyond just holding on to a book that you haven’t (and probably won’t) read because you paid full price for it, here are some potentially more serious ways where sunk costs may be impacting our lives in more dramatic ways:

  1. Career choices. According to Gallup, 34% of us are “engaged” at work. That leaves the rest of us, effectively two-thirds of us, somewhere other than “engaged.” In many cases organizations may be counting on the sunk-cost mindset to retain a dis-engaged workforce (a topic for another time). Maybe you are at the point in your career where you are reconsidering the quality of how you spend your days and years, where your career is headed, and how you arrived at this place. I’ve mentioned before that the Career Fit test we offer for marketing and lead generation is one of the most widely used of our assessments; it seems that many of us are drawn to the idea of trying to understand how we really fit with our chosen careers and whether we are on the “right” track. The sunk costs that you are wrestling with may include the cost of your education, the time you spent climbing the corporate ladder or acquiring skills, and the network you’ve built. While the cost of switching may seem high, the analysis is not complete without considering what costs will be incurred over the long-term if you don’t make a change.
  2. “Expensive projects” (e.g., a small business). This one is particularly relevant for me as the operator of a small business. Thinking about the costs that have gone into creating a business, including the capital invested, the time spent, and the impact on personal relationships, it would be very challenging to even consider abandoning those sunk costs in order to pursue something new or different. A good piece of advice here, again from Professor Godin, is to try to determine whether you are in a dip or a cul-de-sac–the former is worth pushing through (because you will emerge on the other side), but the latter is not because it’s a dead-end.
  3. Professional relationships: Whether we’re talking about the person that cuts your hair or prepares your tax return, developing relationships with professionals can be time consuming and emotionally expensive. Maybe the person you’re working with was a referral from a friend, and you feel the cost of what that friend would say if you left is too high. As a result of those perceived costs, even the thought of alternatives may be off your radar (e.g., “do I really want to spend the time and energy to find a new CPA?”). But if the counsel or service you’re receiving consistently underperforms–just like an investment in a stock–then consider the continued cost of engaging with that professional over the long-term and try to open your mind to the possibility of a new relationship. It will cost you an investment now, but could pay long-term dividends for years to come.

We should all be able to say: “what’s done is done.” But identifying expensive sunk-cost attachments can be difficult. How do you know if you’re holding on to sunk costs in important areas of your life? That question has to be answered through self-reflection. This article has a list of insightful questions that can help you identify sunk costs as you look at your career, household, and financial decisions and plan for the new year. Here are a few to consider:

If you were observing someone else in the same predicament, would you recommend that they stay with their sunk costs or get out? We are usually much better at giving up sunk costs in advising someone else because we are not trying to justify our own behavior. We are talking about someone else.

Have you given up on sunk costs in the past? Are you glad that you got out while you could? Did anything positive follow from giving up?

Maybe it’s just a bag of clothing that can be donated as a result of coming to terms with your sunk costs. Or perhaps it’s deciding to leave behind a degree and years of experience to begin a new career path. Spending some time quietly reflecting on these costs that you’re holding on to can be a productive undertaking. As we move into a new year, before writing those resolutions, consider “giving away” a host of old gifts that you have given yourself to begin something new, and perhaps more rewarding.

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