Bad Boyfriends & Bad Investments: Dealing with the Sunk Cost Bias

My daughter’s friend has a bad boyfriend. He steals money from her purse, plays manipulative games and doesn’t treat her with much respect. But she won’t leave him. When my daughter encourages her to break it off, the friend rationalizes. “We’ve been together for 5 years. I can’t just throw that all away!”

I can’t just throw that all away.

I explained to Emma that her friend was trapped in what’s called sunk cost bias. It’s an economic term (also known as sunk cost fallacy) describing an error in decision making. Basically, we allow past decisions or events to overly influence future decisions. We let what was trap us and lead us into irrational decisions about what is.

From the outside, it’s clear that Emma’s friend is not with a good guy, and she should leave. But from the inside, she likely feels that she can’t because then she’d have to face her mistake. She’d have to face all the bad decisions and rationalizations that she’s made.

Don’t be too hard on her; we all do it. Maybe it’s the dead-end or soul-killing career you can’t leave. The bad investment still on the books that you just can’t sell (especially after you’ve already averaged down). The advisor you’ve worked with for years that doesn’t return your calls. The money pit of a house that you keep pouring more into. Even the bad book you feel obligated to finish.

I’ve done it too. Early in my career, back when I traded technology stocks, I lost a lot of my money(and clients') to sunk cost bias. One stock in particular taught me a hard lesson. I had built a large position in it based on the promise of an “amazing new product.” When the stock went down, I bought more. When there was a “temporary setback” announced, I bought more. Once it was clear that the amazing new product wasn’t all that amazing, I couldn’t sell. In fact, I bought a bit more…and waited. Then the bad news came. An investigation was announced. Still I held my position. Fraud was discovered. Still I held my position. The stock plummeted. STILL I held my position. The thought of selling it made me sick. It was easier for me to hold on than to sell and face my horrible decision making.

Avoiding sunk cost bias is now one of my ninja skills. I’m pretty adept at accepting my mistakes and losses and moving on. The way I see it, on any given day it’s up to us to allocate our resources to create a great life. Money, investments, time, attention are ours to allocate. I refuse to be trapped by my past.

A big part of my work is challenging clients not to get trapped in what was or what is. Whether it’s their investment portfolio, work or goals, I help them free themselves so that they can proactively work towards the life they want.

Have you been caught in the sunk cost bias trap? How did you get out?