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This section was my workspace for philosophy essays between July 2006 and April 2008. I call this "Prehistoric Kilroy" because it gave me practice for more disciplined essays in Kilroy Cafe. Also see my philophical blog and Twitter feed.

Issue #20, 9/19/2006

The Investment Effect

By Glenn Campbell
Family Court Philosopher

As I watch some divorces unfold in court, I often wonder: How could a relationship this bad have gone on for so long?

The answer often involves a certain fallacy that is common to investors everywhere. You see it all the time in our fine casinos. A gambler has already lost a huge amount of money on the slots or roulette tables, but because they have already "invested" so much, they feel compelled to continue.

The more you have invested in a certain venture in the past, be it a business, a marriage, a hobby or even a personal opinion, the more you feel compelled to "stay the course" to justify your past investment. To "cut and run" seems like a defeat, because it means that all of your prior investments were useless.

Psychologists call this the "sunk-cost fallacy." You have already "sunk" a substantial amount of your resources into a project, and this creates an ego-investment in the outcome that can cloud your reasoning. To abandon the investment now would result in a huge immediate hit to ones self-esteem. Of course, the only problem with not accepting the painful loss now is that you might have to accept an even bigger loss later.

Psychologists, economists, social scientists and statisticians would all agree that sunk-cost is a "fallacy," a logical error in judgment. The fact that you have already dropped $20,000 into the slots has no effect whatsoever on the outcome of the next try. Your odds of winning (or losing) are exactly the same as they were on your very first pull. The past $20,000 should be completely irrelevant to your current decision-making, but emotionally it still compels most suckers to keep going.

I prefer to call this "the investment effect." This is a mode of reasoning that effects all of us, every day, and I contend that it is one of the most powerful hidden forces in human behavior. We do many things not because they are the wisest decision right now, but because we have already invested in this road and can't bear to turn back.

This isn't just limited to obvious things like marriage. It also affects attitudes, lifestyles and emotional knee-jerk reactions. If you have "invested" in anything, including foolish or costly decisions of any kind, then there is a pressure to continue with that policy to avoid losing face about your past.

I think that people can even become invested in a life of crime, precisely because of its cost. If you steal a car, and you are caught and given a punishment for it, then, if you are rational and insightful, the punishment might deter you from doing it in the future. However, for someone whose ego is so weak that they can't admit they were wrong, the high cost of the criminal activity might actually justify its continuation. They might say: "Why did I invest a year in jail? Was it no use whatsoever? No, I'm going to continue stealing cars, but I'm going to do it better this time so I won't get caught."

The investment effect can shape ones political opinions as well. Democrat or Republican, hawk or dove — it often depends on what you have already invested in personally.

As a young person not knowing what to do with your life, you might decide on a whim to join the military. That decision, once made, needs to be continuously justified, probably for the rest of your life. You go through basic training, which isn't easy; you get yelled at and humiliated by the drill sergeant, and when you come out of it, yes, you do believe in the military, because how else can you justify all the pain you have been through?

Your decision to join the service, especially it it was a hardship, becomes part of your personal mythology. Henceforth, your political opinions and your choices about your future will evolve in such a way as to support your initial investment.

High-cost relationships, including marriage, are certainly subject to the investment effect. If I have already put 10 years of my life into a relationship, then I am probably going to continue with it, even if it is rather dull and dysfunctional and I wouldn't choose it again. "Look at all we have been through," can justify a lot of bad partnerships.

The fact is, most people won't abandon existing relationships that are dull and unrewarding—that is, that are only mildly dysfunctional. Instead, they require "cause" before the relationship can end, and it may take years before this cause becomes sufficient for action.

The investment effect is so pervasive in human decision-making that I hesitate to even call it a "fallacy." It is "lifestyle decision." It is something that we must accept in others and not criticize. Certainly, if we did criticize the investment-based decisions of our friends, they would not be our friends for long.

But the sunk-cost fallacy is not something that you are I should follow, enlightened beings that we are. Every decision must be made on its own merits, according to how the future costs and benefits add up right now, regardless of the past investment. If we must walk away from a $20,000 loss at the tables, so be it. The ability and willingness to make such brutal choices are the true test of wise decision-making.


Links

An article in the L.A. Times on 9/17/06 discusses The Sunk-Cost Fallacy, mostly in relation to the Iraq war. It also defines the concept in general.
    YOU'VE PAID $10 to get into the movie and it just plain stinks. The plot is ridiculous, the acting is terrible, the violence is excessive. But you've already watched half of it. Do you sit through the movie to the end or do you leave?

    Just a month ago, you spent $2,000 getting your 10-year-old car's transmission rebuilt. Now you find out the car is leaking oil and needs a ring job. Do you spend the next thousand or buy a new car?

    You've been living with your romantic partner for 10 years. The relationship has had its ups and downs, and both of you have invested a lot in keeping it going. But every day it seems to involve more work and less joy. Is it time to move on?

    You work for a private equity firm and personally persuaded your skeptical partners to invest $2 million in a high-tech start-up. Now the chief executive comes to see you with the news that they've hit some snags in developing their product, and they'll need at least another million to bring it to market. Do you write the check?

    We've all encountered situations like these. We make a significant investment of money, time or emotion in some project, relationship or business deal, and it doesn't seem to be working out. Do we continue to "throw good money after bad" or do we "cut and run" and "stop wasting time"? What's the right way to think about such decisions?

    Psychologists, decision scientists and economists have an answer. They tell us that it's a mistake to continue with a project or an activity because of what you have already invested in it. The time or money you've already spent is gone. You can't reclaim it. Using a past investment to justify a future investment is what they call the "sunk-cost fallacy."

    Instead of thinking about the past, what we should be doing is thinking about the future. "Will my life be better if I leave this terrible movie or if I stay to the bitter end?" "Will my car give me 20,000 more trouble-free miles if I just do this one last repair?" None of these questions have sure answers. Life is full of uncertainty. But what we can say is that if the reason for "staying the course" is past commitment sunk costs we need to find a better one....

    We heard this argument often enough in the 1960s. As casualties mounted in Vietnam, it became more difficult to withdraw because withdrawal would have "cheapened" the lives of those already sacrificed. We "owed" it to the dead and wounded to "stay the course." What staying the course produced was thousands more dead and wounded. "Knee deep in the big muddy" is how folk singer Pete Seeger described it. The question should never have been, "What have we invested so far?" but "What are our objectives for the future and can we attain them at a reasonable cost?"...

    Yet people seem willing to waste even more (time, money or lives) to justify what they have already spent and avoid that sick feeling of failure. Think about it. You haven't really lost money on a stock whose share price keeps plummeting until after you sell it. So you keep holding on, in the hope that your judgment as an investor will eventually be vindicated. And troops haven't really "died in vain" as long as you continue to press on in the fight, no matter how disastrous the results.



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Page Started: 9/19/06 Keywords: gambling fallacies