In investing, people commonly make the same mistake: when a share is doing well they sell some or all of their investment, but when a stock is going down they hold it tight. After all, it feels safer to take some profits from a rising share, and it's painful to take a loss on a stock that has dropped. The best thing to do is usually the opposite: run your winners, and sell your losers. (Automated stop-losses can help us overcome our human cognitive fallibility).
This error is a result of what is called the sunk cost fallacy, or sunk cost bias. This means that the more that we have invested money, energy, time or emotion into something, then the more reluctant we are to give up on it. It's easy to see in finance: people have invested so much that even though they know things are going badly, they are reluctant to sell. Many people even invest more money as their investment falls, convinced that it will pick up again. A stock market adage is "never try to catch a falling knife". This tenacity is a testament to our conviction that we've made a good choice, but also to the pain of losing money.
Sunk cost bias is also evident in relationships. Couples who have been together a long time - even when things are consistently bad - have a difficult time making the decision to separate. I know two couples who got married after being together for many years; all parties had misgivings in the lead-up to the wedding, but they went ahead anyway. Both were separated within a year. The sunk cost here - years spent together, time and money invested in planning the wedding - is huge.
Somebody that we've hired may turn out to be a poor employee, even after we have put in lots of time guiding and mentoring them. It's hard to admit to ourselves that our choice isn't working out, and hard to cut the relationship off.
People invest huge amounts of emotion in arguments about emotive topics. This makes it hard for us to back down from our original position, even if we start to realise that we are wrong. It can be embarrassing to admit a mistake, especially after passionately arguing a point.
There's no complete escape from sunk cost bias; it's a part of being human. In investments and with employees we can look at the situation and ask: "would I buy this stock or hire this person right now with all the information I currently have?". In relationships we can slow down, spend time apart, and put a hold on any big plans. And in arguments we can pause; in the heat of the moment it's hard to admit we were wrong, but a lot easier to say, "ok that's interesting, I haven't thought about it that way before. Let me have a think and we can discuss it further tomorrow". This pause is vital, allowing us to review our position while saving face.
When things aren't working out, take stock of what you have already invested. Then consider how you would act if you were starting fresh.
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