Do You Fall for Sunk Costs? Few Easy ways to Tackle Themđ
Do You Fall for Sunk Costs? Few Easy ways to Tackle Themđ
Wisdom Letter #84 | The Sunk Costs Fallacy
âWhen the Facts Change, I Change My Mindâ â John Maynard Keynes
Heyđ
Whatsup
How are You?
How do you make decisions? Do you learn from your past, when you make decisions for your future?
Of course, you do.
But how do you factor in your past when making those decisions?
Do you let your past mistakes weigh down your future? Or do you take every decision based on the present?
Today, we talk about our tendency to incorrectly look at the âcostsâ of the past as the âinvestmentsâ for the future.
We talk about the cognitive bias called The Sunk Costs Fallacy.
Read On.
What is The Sunk Costs Fallacy?đ€
The Sunk Costs Fallacy is our tendency to stick with poor past decisions because we are too deeply invested in them.
We think of those past costs as investments.
And we donât want to back away from those investments right before they start paying dividends.
Without realizing that those supposed âinvestmentsâ are actually âcostsâ that are dragging back our ability to make sound future investments.
This model comes from accountancy, where the costs already borne for a business and cannot be recovered anymore are called sunk costs.
You know stuff like buying heavy machinery and equipment. Stuff like that.
But this concept applies to a wide array of fieldsâ like business, finance and even personal relationships.
Let see.
Some Practical Sunk Costs
đ° Finance
This is a classic example.
Think of a stock you bought at a price of 100, with the hope of reaching 120.
But it falls to 95, then 90 and then 85.
Maybe the fundamentals of the business changed, the management walked out, or the business got hit by a pandemicđ
Now, how long will you hold on to it? till it falls to 80, 70, 60?
The longer you donât sell, you are locking up your capital and losing out on other opportunities that may be benefiting from the change in the environment.
And what if the stock bounces back right after you sell?
The nuance here is not whether you should sell or not, itâs not about whether you shed your sunk costs or not.
Itâs about how much weight do you give to your past decisions.
If you decide to hold or buy more of the stock today, then it should purely be based on the conditions of the present day. Your past investments shouldnât matter.
And after careful analysis, if you decide that itâs not a good stock to buy today, then you should sell it off.
Thatâs why professional traders have the concept of a preset Stop Loss.
A stop-loss takes away the messiness of cutting out the sunk costs.
At the time of buying they know the rationale of why they are buying, they have the humility to accept that they can be wrong, and prudent enough to cut losses when that happens.
Enough about finance letâs look somewhere else, and some shorter examples.đ
đ Relationships
The longer you have been in a relationship, the likelier you are to stay in it.
And itâs not necessarily because the relationship is getting any better.
You stay because you think you have already invested so much of your time in it. You canât possibly do that again with another person. And what happens if you try and even the next relationship turns out to be the same?
Under the pressure of this creeping self-doubt, millions of people around the world keep sinking deeper into the ocean of their past decisions.
Whether you stay in a relationship or not should depend on how you feel about it TODAY. And do you feel confident that the relationship can add value to your life going forward? It should have nothing to do with what happened in the past.
Sure, look at the past for data, gather information, but in a distant and rational way. Try to decide like you were making a fresh decision.
Would you want to be with the same person, if you met them today?
đĄThe Wisdom Project
This one is interesting, and personal.
We have been writing this newsletter for 84 weeks now.
For a long time, it was just the streak that kept us going. We were finding it really hard to do, writing every week, coming up with topics, curating content, writing our commentary on it.
We thought about quitting, but we kept going because we had already done 30, 35, 40 weeks.
We didnât want to quit right before striking Gold.
We were, in a way, falling for the sunk costs â This project was not adding as much value as we had thought it would when we started. It was a lot of Gruntwork for no real rewardđ
At the end of last year, we sat down and re-evaluated.
We were ready to quit if thatâs what it took.
We reflected on how can this project add more value to our lives? How would we do it if we were to do it today? If we started afresh, with a clean slate, what would we put in the Sunday newsletter?
We came up with lots of ideas, and almost all of them pivoted away from the original format and tone.
But thatâs what made sense to us at the time, and thatâs what we went ahead with.
Since then there has been a change in the tone of writing, the content, and style of the posts, and we have branched out to other projects.
We wrote an ebook, created another newsletter, and just started a new blog. All within the last 3 months.
Now it takes less time for us to write, its more fun, and we are also seeing way better growth than before.
We managed to not fall for the sunk costs and pivot into something more valuable with this project.
How Should We Tackle The Sunk Costs Fallacy?
From what we have learned so far, there are 3 important steps to tackle Sunk Costs Fallacy:
Know Itâs A Cost. Donât live under the illusion that your past decisions were investments. Think of them as costs, and objectively evaluate if those costs add any value to you now or not.
Re-evaluate your Decision. Rethink about your decisions with an open mind. Nothing in life is set in stone. Be nimble, assess your decisions and change them if needed.
Know Your Stop Loss. Have some humility and accept some losses. Be ready to walk away from past mistakes. Be ready to change your own mind.
The ability to comfortably change your mind is at the heart of prudent decision-making.
Successful decision-makers donât make one off great decisions, instead they follow a rational process and are always open to re-evaluate their decisions.
They iterate and evolve their process and over time become masters at the craft.
Message from the great John Maynard Keynes rings true - âWhen the Facts Change, I Change My Mindâ
Thank You for Readingđ
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ICYMI đ Survivorship Bias | Wisdom Letter #83
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This was Wisdom Letter #84. In case you want to revisit any of the previous 83 letters, check out our entire archive.
Love,
Aditi & Ayush