Knowing when to cut your losses

Romeo Santos - arguably the most well-known singer in the bachata genre globally - performs tonight at the O2 Arena in London.

Imagine you spent £80 on a ticket to the concert a few weeks ago. It is the day of the concert, which we will pretend will be performed outdoors. You feel extremely unwell, it is cold and windy outside, and rain is looming. You know it will be a struggle to enjoy the concert, and you risk becoming more ill by going.

Though the costs outweigh the benefits, why are you still likely to go to the concert?

The explanation comes from the sunk cost fallacy. We continue to invest resources (time, money, or effort) into a decision or project because we have already invested in it, regardless of its diminishing returns or lack of future prospects.

The sunk cost fallacy

Intuitively it makes sense; we don’t want to ‘waste’ previously expended resources. If we quit everything when it gets a bit hard, we likely wouldn’t be very successful in our lives. Examples that come to mind are studying for exams, difficult relationships and learning new skills.

However, sometimes it is in our longer-term interest to cut our losses. Working through a difficult period in a successful relationship, and staying in an unhealthy relationship just because of the years already invested in it, are two very different things.

To help with this, it is helpful to consider the concept of ‘utility’. In economics, utility is the satisfaction or benefit we get from consuming a good or service.

Let’s return to the concert example again. We spent £80 on the concert ticket because we expected to gain positive utility from attending. (Just seeing Romeo perform Obsesión - one of my favourite songs growing up - live for me would make the cost almost worth it)

However, today, the utility we will likely get from the evening is negative. The cost, on the other hand, has already been incurred; it is ‘sunk’. So going or not going, the cost has already been incurred. The only thing that happens by going is that we become more ill, which doesn’t sound optimal or rational.

The money previously spent should not be a factor in our current decision-making. If acting rationally, it is only future costs and benefits which should be taken into account.

Implementation idea

When in a position where you’re considering whether to continue with a decision or project which does not appear to be as attractive as it once was, remember that resources already expended will not be recovered, regardless of the decision. Rational decision-making should be based on current and future costs and benefits, not previous ones.

Best, Alex Joshi.

On my bedside table:

• Fiction: The mountain shadow by Gregory David Roberts (link)

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