Sunk Cost Fallacy | Behavioural Science in Banking


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Are you one of those people who can’t seem to give up on something you have invested time, effort, and money into, even if it’s no longer worth it? If that sounds like you, then you might be falling for the sunk cost fallacy! But don’t worry, you’re not alone. Even the smartest fall prey to this cognitive bias, especially when it comes to finances!

What is sunk cost fallacy?

Sunk cost fallacy is a cognitive bias that occurs when people continue investing in a project or decision even if it’s no longer viable or profitable. Why? Simply because they’ve already invested time, effort, and money into it and so abandoning the project or decision now, can feel like a waste of the already invested resources (Arkes & Blumer, 1985).

Imagine you bought a ticket for a movie, but halfway through, you realise that it’s terrible. You have two options: leave and do something else or stay and watch the movie until the end. By staying, you may be wasting more of your valuable resource, time. If you leave, you may feel like you are losing the time and money invested so far. This conflict relates to sunk cost fallacy and the same principle applies to financial decisions.

Why does it happen?

Sunk cost fallacy occurs because people naturally tend to avoid losses, even if it means continuing to invest in something that is no longer profitable. Additionally, people often attach emotional value to things they’ve invested in, making it harder for them to let go. This bias can lead to irrational financial decisions and keep people from achieving their financial goals.

Let’s say you bought shares of a company that have been consistently declining in value. Despite the downward trend, you continue to hold onto the shares because you have already invested a large sum of money and don’t want a loss. This way of thinking might cause you to overlook better chances to invest, which could eventually result in even more losses.

Another example could be continuing to pay for a subscription service that you no longer use or need, simply because you have already paid for it in advance and don’t want to “waste” the money you’ve already spent.

In what ways can banks use sunk cost fallacy to empower individuals to manage their money more effectively?

Financial institutions can help their customers beat the sunk cost fallacy by offering helpful financial guidance and tools. These tools can help them make rational decisions based on the present and future, rather than past investments. For example, banks can offer budgeting and savings tools that enable customers to track their expenses and create financial goals. This approach encourages customers to focus more on their future financial objectives rather than just what they’ve already put in (Tversky & Kahneman, 1991).

Moreover, banks can offer individualised financial tips and support to assist customers in recognising when they’re caught in the sunk cost fallacy and how to break free from it. This way, customers can make wiser money choices that match up with their larger financial plans.

Conclusion

Getting past the sunk cost fallacy can be a challenge, especially in money matters. But, by understanding what this bias is all about and how it works, financial institutions can lend a hand in guiding customers toward wiser financial choices that align with their long-term goals. With the right financial knowledge and tools, customers can shake off the sunk cost fallacy and work toward a more secure financial future.

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