How to know when it's time to cut your losses

People watch the final Concorde flight land at Heathrow Airport in 2003. Although the venture was hit by cost overruns, everyone involved followed through because they had already made significant financial investments. Getty ImagesShow less

In 1956, the British Supersonic Transport Aircraft Committee met to discuss building the Concorde, a supersonic masterpiece of aviation.

Engineers from both France and Britain, as well as representatives from both governments, were involved in the project that was estimated to cost an eye-watering $100 million.

Fast forward to 1976, when Concorde's first commercial flight took place, and the venture was already plagued by excessive cost overruns. By the time the last Concorde flew in 2003, this financial calamity had become notorious.

Everyone involved followed through on the project because they had already made significant financial (and time) investments. Unfortunately, for themselves and the taxpayer, they accepted their mistake almost 30 years too late.

The “sunk cost fallacy” is the only comprehensible reason two countries would waste so much money for so long.

The sunk cost fallacy is a mistake in reasoning. It occurs when a person is faced with a decision on whether to continue an activity or not based on the cost already incurred, rather than future costs and benefits.

You may also know this as “throwing good money after bad”. As 19th-century British economist John Maynard Keynes once said: “The difficulty lies not in the new ideas, but in escaping the old ones, which ramify, for those brought up as most of us have been, into every corner of our minds.”

As Keynes suggested, sunk cost is everywhere. It shows up all the time in our small, everyday decisions.

Perhaps you keep eating even though you are full because you’re paying or have already paid for the food. Perhaps you continue reading a book you’re not enjoying because you have already invested time and/or money in it.

These are obviously relatively small decisions, but the sunk cost fallacy can also show up in larger decisions.

“I’ve invested so much into this business venture that I might as well keep investing money into it” or “this career isn't fulfilling, but I’ll stick to it because I've invested so much time into it and my education” or “this relationship is bad for both of us, but we’ve been together for so long that we need to make it work” are just a few examples of larger sunk cost fallacies.

Falling prey to the sunk cost fallacy is a psychological trap, not least because we're not purely rational decision-makers and are often influenced by our emotions and past decisions.

If we've invested in a choice, we're likely to feel guilty or regretful if we don't follow through. And the more we invest, the more we feel obliged to continue and plough more resources into it.

The good news is we can minimise sunk cost impact if we remove our focus on the past and focus on the future

Sam Instone,
co-chief executive of AES

It’s a vicious cycle. In the financial world, it’s something we see all too often. The good news is we can minimise sunk cost impact if we remove our focus on the past and focus on the future.

Ask yourself: if I was not already doing it this way, is this how I would begin today?

If the answer is no, quit. Ignore and accept the sunk costs and rethink your decisions and actions.

Quitting can seem risky or like failure. But the worst thing we can do with limited time — the only non-renewable resource — and energy is to continue on the wrong path.

Sam Instone is co-chief executive of wealth management company AES