The «Sunk Cost Fallacy» is itself a fallacy
Investing time, money or resources even though it hasn't made sense for a long time. But you don't want to waste the previous investment - so you keep going.
The Sunk Cost Fallacy is a phenomenon where people tend to continue investing in a project or decision just because time, money or resources have already been invested. And this is regardless of the actual results.
This means that investments already made that cannot be undone (the "sunk cost") unduly influence our future decisions when they should be irrelevant.
A harmless example from everyday life is when someone goes to the movies, realizes that the movie is boring, but still finishes watching the whole movie because, after all, money was spent on it.
A fatal example is sticking with a project. When a company spends a lot of time, money and other resources to realize a project that just won't work, statements like "We've already invested so much, we can't stop." often come up.
The costs have long since exceeded the benefits. This is called a sunk cost fallacy.
How does the sunk cost fallacy come about?
There are several reasons for this. Mainly, it's because people don't make purely rational decisions and we are often influenced by our emotions.
And this starts with the ego. If someone invests in a stock and holds it, even though another stock makes more sense, they would have to admit to themselves that the original decision was wrong. Many don't want to do that.
Additionally, many have a sense of personal responsibility. Giving up something we started is difficult.
The Sunk Cost Fallacy also occurs because of loss aversion. This means that the impact of losses is worse for us than the impact of equivalent gains. We are more inclined to avoid losses than to seek gains. We may feel that our previous investment is "lost".
The main problem is optimism
Optimism is good. However, unrealistic optimism is not. People tend to overestimate themselves - especially their chances of winning. The opposite is true for chances of loss. This thinking is the main driver of the Sunk Cost Fallacy. But does that make optimism wrong? No. Otherwise, no one would do anything anymore. And that is my criticism of the Sunk Cost Fallacy.
The Sunk Cost Fallacy itself is a fallacy
I argue that the Sunk Cost Fallacy is itself a fallacy. The Sunk Cost Fallacy Fallacy. Why? It's not so easy to figure out whether you're investing in vain now or you're better off holding out. No one can see into the future and even data is no guarantee.
Let's take stocks. It may be that stocks are valued extremely low for months. Everything suggests that it will stay that way forever. Then news comes, the stock recovers and the sunk cost fallacy is invalidated.
Or companies or new business models. Here it is necessary to constantly question, calibrate, test new things and draw conclusions. Especially in the beginning, this requires a lot of perseverance. But when is the effort in vain? Some work for 7 years and have no success. Suddenly the breakthrough comes.
An extreme example: The James-Webb-Telescope
The planning of the James Webb telescope took 20 years and cost 10 billion US dollars. Everyone involved was under intense pressure from the government on several occasions. But in the end, the project succeeded and the James Webb Telescope was able to start its journey into the universe on December 25, 2021.
Today it is the most modern telescope, which provides us with valuable data that we could not obtain before. 20 years it took. 20 years of thinking about the Sunk Cost Fallacy. To the benefit of mankind, the team did not give up despite public pressure.
Elon Musk is not fazed by the Sunk Cost Fallacy and keeps going. No matter how many rockets fail to make it. No matter how many critics there are. Many entrepreneurs do it this way. In fact, there's no other way.
A healthy optimism is important, because how else are startups going to happen? Or inventions? No one would take the risk of founding something, no one would try anything else.
And that would be fatal. Also when it comes to investing. Nevertheless, the sunk cost fallacy should not be demonized. However, it is important to deal with it correctly.