In for a penny, in for a pound

This was supposed to be the second in the series of short articles about logical fallacies and other common mistakes of thinking. But I started writing and it turned into something longer, because it’s such an interesting topic. Such is life! I hope you enjoy the read.

We all make mistakes sometimes, but being aware of what they are and why we make them can make a real difference.

What’s the worst film you’ve ever watched? Now your answer to this question will likely be different from mine, but some famously bad movies include:

• The Room 
• Gotti
• Cats
• Batman & Robin
• Wild Wild West
• Star Wars: Episode I – The Phantom Menace
• The Godfather III

Whatever your answer was to the question above, here’s another one – did you watch the whole thing? For my part, I did indeed sit through more than 2 hours of Jar Jar Binks. The reason I did, rather that walking out or turning it off after an hour, is the sunk cost fallacy, the human tendency to continue down a path to which one has already committed resources, even when doing so only wastes even more of what we’ve already invested, whether that’s time, money, emotional energy or whatever else.

We see this in all sorts of areas of our lives, from the relatively trivial such as watching all of a film we don’t like or reading all of a bad book, to the life-changing such as staying in a bad relationship or an unfulfilling job.

There are lots of reasons why we do this; our natural instinct for loss-aversion tends to be stronger than our desire for making gains and from an evolutionary point of view it can be advantageous to have a degree of in-built conservatism. However, modern life choices are far more expansive than they’ve ever been, and the historic patterns of human behaviour don’t always translate across to make for good decisions based on our initial feelings for a situation.

In pure economic terms, a sunk cost is one that’s already been incurred and can’t be recovered.

Here’s a slightly different example of how that creates problems for people’s decision-making from Daniel Kahneman and Amos Taversky (Kahneman’s book, Thinking, Fast and Slow, is a must-read, seminal work in the history of decision-making science, and he won a Nobel prize), to show how we mis-evaluate the cost we’ve invested in things. It’s a thought experiment you can do on yourself:

You go to the cinema with your friends, and a ticket is £15. You get to the till only to find that you’ve lost the £15 that was in your wallet, and now you have to pay by card instead. Do you still buy a ticket? If you say yes, then you’re in the company of most other people; only 12 percent of people in Kahneman and Taversky’s experiment said they wouldn’t.

Now imagine on another day you go to see a film and buy a £15 ticket without issues, but when you get to the ticket check you realize you’ve lost it. Do you go back and buy another ticket? Perhaps, but does that seem worse or more upsetting? In the experiment, 54 percent of people now said they wouldn’t buy a replacement ticket. Financially, the situation is exactly the same. You lose £15 and then need to pay another £15 to see the film, but the second situation feels different.

If you wouldn’t want to pay another £15 in the second scenario then logically, you should say the same in the first scenario. But that’s not how people think; the ‘cost’ of both scenarios is not viewed equally. 

This difficulty in making decisions based on the perception of past investments is hugely important when we are advising clients. The client who won’t settle on receipt of a sensible offer because the offer has come ‘at the door of court’, when so much preparation has been done and hearing fees have already been incurred, is likely influenced by the sunk cost fallacy. Even though they would be content with that outcome as the decision of the court, or even if they would accept it one week later.

Or the client who would rather keep their business and buy out their ex, when the business is one that makes only a modest profit and where the profits from a sale would generate a better return if invested in an index fund. In purely logical and financial terms this is a bad decision – why generate 3% profit per year in your business when you could get 10.26% in the S&P 500* – so it’s vital to see that people don’t make decisions based purely in logic and numbers.

What’s interesting within such an example is the potential for different people to take completely different, but all equally valid, conclusions away from it. 

Step one for many clients in this situation is simply to see with open eyes that they are making such a decision; I’d venture that the majority of people in such a situation don’t even realise that in keeping the business, they are in fact deciding not to invest the money instead, and so don’t even realise that there’s more to the decision being made in the background. There's a certain irony in the fact that one of the common mistakes of thinking people make is to not realise they are making mistakes in the first place.

Second, some people may then decide to actually sell-up, take the higher returns available, and go in a new direction. Perfectly justifiable decision, and a great example of a situation where, by helping your client see that they are making a choice – not even helping them to make it one way or the other – you are making a real difference to their future. If you’d never taken the time with the client to talk about why they say want to keep the business, and what other options there might be instead, then they may have missed a chance to make a positive change in their life.

Third, and maybe most interestingly, would be the set of people who would keep the business anyway. Perhaps in doing so they are continuing a family legacy, or carrying on in a job that gives them fulfilment and meaning, and where profit isn’t the most important thing. It can be empowering to properly crystalise one’s values, and to find a way to prioritise them. But unless and until that client understands these are the key components of their decision, they won’t be able to prioritise properly and you won’t be able to advise them as well as you could.

I end with a simple challenge: to find in your own decision-making a sunk cost or two that you are chasing and ask if you even realise that’s what you’ve been doing. What other choices are you making without even realising?

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*This article does not give financial advice, the point being made is rhetorical. Go and see a financial advisor!

 A related article about Commitment Bias can be read here.

 Today’s video is Empire by Andy Warhol.

 Today's recommended track is Too Long by Daft Punk.

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Get in touch if you’re interested in any of my services. As well as a barrister I’m also a trained mediator, hybrid mediator and high conflict specialist.

My legal services are offered separately via my chambers website; my clerks manage my legal and mediation work and their contact details are here. I also offer in-house training on a variety of subjects including first client meetings. I offer individual and firm-wide consultancy on improving productivity, wellbeing and communication. To get in touch with me direct, please subscribe then go to the Contact page above.

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