The Investment Effect

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.

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