One very important fallacy is called the ‘Sunk cost fallacy’ – which makes us throw more good money after money already gone bad. Typically a lender keeps lending money to one customer hoping that this will enable the borrower to do well and repay ALL the money. Another manifestation of this is called ‘Averaging’ – if I thought Xyz was a good buy at 83…it has to be a GREAT buy at 23. This is the logic. Not true. The worry is – sometimes it is true. So chasing the rainbow can be quite a battle.

This comes to play when a person keeps on paying premia on the shit policies that they have bought. Imagine telling a person “Surrender this lousy policy” and he/she comes up with…’you know I have paid Rs. 9 lakhs over 6 years and if I surrender it, they are not EVEN GIVING ME Rs. 8L – how can I surrender at a loss? Now this person will CONTINUE to pay premia without REALISING that they LOSS is already incurred….LONG Back.

Suppose I have promised my Mother and Daughter to take them to a play. Both of them were very enthusiastic a week before the play. However on the day of the play (it is at 6 pm, and it is a 24 km drive) at about 3 pm, my mother is feverish. My daughter is almost indifferent because suddenly she has got a birthday invitation for 7pm. I am myself not too keen to drive in Mumbai’s blinding rain. Frankly not sure whether the play can take place – the rains may not allow enough people to reach.

How do I react to this situation:

Consider 3 scenarios:

a. Some Investment company has given me 3 free passes

b. I paid Rs. 3000 for this play

c. I have to go there and buy the tickets

In case of (c) it is easy to drop the plan. In case of situation (a) it might cause some embarrassment to explain why I could not make it.

However in case of (b) – my Mom knowing I have paid 3k may hide her fever (why lose 3k), I may risk skidding on the road, my daughter may not go for the birthday party. We might go to the play – which may not happen, my car could skid, my mom could develop high fever…all this for 3k which was SUNK already!

Thus the most sensible solution (tear the tickets dammit!!) is not so easily visible. That is sunk cost fallacy.

However if you have joined a swimming pool and paid Rs. 12k for the year – you are likely to pull yourself on a cloudy day, rainy day, lazy day, cold day,….BECAUSE you have paid the money. However if you had to pay Rs. 175 every time you went to the pool, and it involved spending Rs. 40 on auto (or Rs. 25 on your car)….you might have an EXCUSE! So ‘sunk cost’ works here – IT FORCES YOU TO go….!

So understand where you do not want the sunk cost theory to work, and where you want it to work….and then act accordingly!

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  1. Hi Subru, Liked article as always.
    One exception of your second example,that is me!!!
    First time in my life(in more than 10 years)I joined in Sport Centre(Gym)with
    Direct Debit from my bank account.
    What is happening now is ,before I used to go for run around 1 hour/10 km.
    And now because of having paid to Gym,having high standard tredmills there(southall sports centre,London)I am not going outside/outdoor for jogging and still not going Gym.What you call this behaviour?
    Why even sunk cost fallacy doesn´t work for me!!!!!

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