Jake Wilder
Dec 28, 2018 · 11 min read

And Stop Wasting Your Time on Bad Investments

A concerned citizens brigade is suing our town council and school board. It’s the latest tactic of a poorly thrown together strategy to prevent the town from building a new elementary school.

They’re upset over the potential increase in tax dollars. So they decided to sue the town.

In their effort to prevent a marginal tax increase, they’ve decided to spend ten times that amount for court litigation. I’m not sure if they realize their tax dollars will also be paying for the town’s defense.

One more instance of a poorly managed campaign that’s only succeeded in guaranteeing their own failure. A strategy that to date has included belittling those with decision-making authority, promulgating alternative fact sheets, and one particularly boisterous woman who drew comparisons between her attempts to block the school development and her grandfather’s role in smuggling Jews out of Nazi Germany.

Yeah, that actually happened.

And while this merry band of self-deluded crazies may be on the far end of the irrationality range, their mistakes are similar to many of the pitfalls that plague the rest of us.

More pronounced and ridiculous perhaps, but similar all the same.

Faced with repeated defeats and setbacks, they had two choices: move on with their lives or double down on their investment.

And despite the overwhelming amount of evidence showing them the futility of their efforts, they elected to continue down a path which is now completely contrary to their original purpose.

As we get ready to start 2019, complete with dozens of goals and aspirations for accomplishing more, where are we pursuing things that are no longer worth the effort. How often do we become so blind to the path that we’re on, we don’t stop to consider whether it’s still the right one. In the wise words of Seth Godin,

“If you’re trying to succeed in a job or a relationship or at a task, you’re either moving forward, falling behind, or standing still. There are only three choices.”

So instead of taking on a dozen new resolutions in 2019, a more effective investment would be to consider which current efforts are no longer delivering value. We all have areas where we’re investing our time, energy, and money without seeing a worthwhile return. If we can cut these out, we’ll have much less constraints on focusing our efforts towards something that will yield a meaningful impact.

Unfortunately, it’s not always as straightforward as looking at a balance sheet and highlighting the red numbers. We have multiple biases and fallacies that trick our minds into looking past these doomed investments and continuing down failed paths.

The key is simply to recognize and counteract them. And manage them before they manage you.

Sunk Cost Fallacy

“No matter how far you’ve gone down the wrong road, turn back.” — Turkish proverb

The Concorde was an engineering marvel. It traveled between New York and London at twice the speed of sound and took less than half the time of a typical flight.

Every aspect of the design was optimized for aerodynamic efficiency while balancing the stability and heat transfer necessary to support speeds that could outpace the sun. It flew on the edge of space where passengers could see the curvature of the earth. You could literally gain back time while disproving Flat-Earthers in the process.

Yet despite these benefits, it was also a complete financial failure. Over the course of four decades, the British and French governments continued to pour more money into the project even when it became clear that the project would never be profitable.

We see this same behavior in our own lives. We overvalue our previous investments — our sunk costs — when determining future investments. How often do we continue pouring time into projects, relationships, and jobs that we know won’t yield a future benefit?

No one likes to admit that they’re wrong or be seen as a quitter. So we stick with a failing strategy in the hopes that it will eventually turn around and our prior decisions will be vindicated. Yet continuing down the wrong path simply because we’ve already been on it for a long time isn’t perseverance. It’s craziness.

The sunk cost fallacy describes our tendency to focus on the past rather than on the future. It pushes us into making backward looking decisions instead of considering which option will yield the greatest future benefit.

We tend to see this behavior most often when we’ve invested a significant amount of time, money, or energy into something. Our investment to date becomes a reason to carry on, even if we no longer see a viable long-term solution.

It’s easy to see how this can quickly become a vicious circle. The more we invest, the more committed we become to keep going, and the less we’re likely to recognize a poor long-term investment.

In his Akimbo podcast, Seth Godin suggests that we treat sunk costs as a gift from our past self to our current self. Stop looking at them as time spent and purely see today’s investment as a starting gift. And with this starting point, then decide which path will deliver the most expected value.

Regardless of how much that gift may have cost, it’s purely a starting point for today. And equipped with that gift, our focus can be limited to considering the future costs against their expected benefit.

Whatever the method, we need to keep our focus on the seeing expected value of our actions, without distorting that view based on prior commitments. Remember that the past is set while our future remains malleable. And remind yourself that there’s no shame in admitting to a past mistake — it just means that we’ve grown wiser than we were before.

Because like Henry Gribbohm learned after spending his life savings, $2,600 in total, trying to win an Xbox Kinect at a carnival — sometimes the costs of continuing on no longer justify the expected benefit. Or in the wise words of Warren Buffet,

“When you find yourself in a hole, the best thing you can do is stop digging.”

Loss Aversion

“If we could be freed from our aversion to loss, our whole outlook on risk would change.” — Alan Hirsch

One of the reasons that I no longer gamble in casinos is that while I’d be happy with a positive gain, I’d be furious over a corresponding loss. The impact of losing money weighed much more heavily than the benefit of winning it.

Studies show I’m not alone in this. Often described as loss aversion, people are on average twice as averse to losing something as gaining it. Put another way, a loss of $100 would provide the same emotional impact as a gain of $200. And there are very few casinos out there willing to offer me these kinds of odds.

Yet we do ourselves a great disservice by allowing our feelings of loss aversion to prevent us from taking future worthwhile risks. Not concerning casino gambling, that’s likely a good decision, but if we’re held to a 2:1 ratio of gains to losses, we’re acting with economic irrationality and missing out on likely gains.

The great economist Paul Samuelson once asked a friend whether he would accept a coin-toss gamble in which he would lose $100 or win $200. His friend replied, “I won’t bet because I would feel the $100 loss more than the $200 gain. But I’ll take you on if you promise to let me make 100 such bets.”

It’s clear that when we apply the law of big numbers, Paul’s friend is much more likely to come away with a gain. Yet his logic in turning down the initial gamble reflects a poor posture on risk. While we’re unlikely to have the same exact gamble offered 100 times, life is full of such risks. If we can stop viewing each of these risks independently and start viewing them as a large group of gambles, we’ll see that we’re much more likely to come out ahead in the end.

This difference of view often comes down to how we see the question — with narrow framing or broad.

Consider that you’re evaluating potential stocks to sell. One has increased $5000 from your purchase price and the other has decreased by the same amount. If you need some on-hand cash and have to sell one, which would you choose?

The majority of people will choose to sell the winning stock, regardless of how well they expect each stock to do in the future. The reasoning is simple — investors often set up individual mental accounts for each stock purchase and want to close each as a gain.

Narrow framing causes us to focus on individual decisions instead of considering the bigger picture. And when we limit our focus to one-time actions, we’re more likely to adopt a risk-averse mindset and settle for preserving the status quo.

In a similar situation, imagine that you have $2,000 in your checking account and you’re asked the following question:

Would you accept a 50/50 chance of either losing $300 or winning $500?

Is your initial reaction to take the risk or stay safe and avoid a potential loss? Now what if you were asked: Would you prefer to keep a balance of $2,000 or take a 50/50 chance of either $1,700 or $2,500?

Both are essentially the same question, yet studies show that many people turn down the first choice yet accept the second.

The difference in reactions is the product of the reference point in each frame. In the first question, we see incremental gains and losses and the thought of losing money triggers a conservative response — narrow framing at work. The second question, however, offers a broad frame reference point of $2,000 and gives a more balanced perspective for a rational financial decision.

To counteract our inherent aversion to loss, look for ways to reframe the problem in multiple ways, looking for both broad and narrow frames. Consider how your thinking changes based on the different framing and reference points. And when all else fails, try to follow Warren Buffet’s advice,

“Take the probability of loss times the amount of possible loss from the probability of gain times the amount of possible gain. That is what we’re trying to do. It’s imperfect but that’s what it’s all about.”

Endowment Effect

“One man’s ceiling is another man’s floor.” — Dan Ariely

If my neighbor offered to mow my lawn for $20, I wouldn’t accept. But if he offered me $50 to mow his comparably sized lawn, I’d also turn him down.

A rational person would recognize the time it takes to mow a lawn and determine an appropriate rate for his time. After which he’d then accept or reject offers based on this singular number.

Yet we’re not rational people. And the value which we assign certain things is heavily dependent based on our level of ownership. As the old saying goes, “No car accelerates faster, brakes harder, or fits into a tighter parking space than a rental car.”

To emphasize this point, Jack Knetsch, Richard Thaler, and Daniel Kahneman designed an experiment in which they gave coffee mugs to half of the participants. The Sellers had the mug in front of them, and the Buyers were invited to look at their neighbor’s mug, after which everyone gave the price at which they would either buy or sell.

The results were dramatic: the average selling price was double the average buying price. The Sellers high price point reflected the reluctance to give up an object they already owned — a clear tendency of the endowment effect.

How many of us have things we no longer use cluttering our basement, closets, and shelves for the simple reason that we’re unwilling to part with them. The endowment effect — a tendency to undervalue things that we don’t own and overvalue things that are ours — keeps us from parting with these outdated items.

Unfortunately, this same fallacy also applies to activities and projects that we’ve undertaken. A failing work project seems all the more significant when we’re leading it or it was our initiative. The struggling employee that’s negatively affecting our team is more likely to get the benefit of the doubt if we’ve hired him. And when new businesses begin to fail, we’re likely to invest more capital to turn them around if we started the company than if we’d purchased it.

In many ways this is a good thing. It drives commitment and accountability and pushes people to drive results in the face of crises. But it can also blind us to a failing investment and become a drain on our time.

To differentiate between these cases, look for ways to separate decision-making from advocacy. When companies go through re-organizations, they often bring on new CEOs from outside. The board doesn’t necessarily believe that an external CEO will be more competent, but they know she’ll have different mental accounts and will be able to make forward-looking decisions without the burden of previous ownership.

Another option is to change the way we frame the question to consider how we’d respond if we didn’t have the same level of ownership. As Greg McKeown suggests in Essentialism,

“Don’t ask, ‘How will I feel if I miss out on this opportunity?’ but rather, ‘If I did not have this opportunity, how much would I be willing to sacrifice in order to obtain it.’”

Focusing on the expected future value in terms of go-forward trade-offs helps separate out the irrationality of past investment and the attachment of ownership.

Status Quo Bias

“Men are always averse to enterprises in which they foresee difficulties.” — Nicolo Machiavelli

The Declaration of Independence warns us that “all experience hath shewn that mankind are more disposed to suffer, while evils are sufferable, than to right themselves by abolishing the forms to which they are accustomed.”

How often do we find ourselves drifting through the same motions, simply because that’s the way things have always been done? Whether it’s a work procedure that no one understands, a series of meetings where no one sees the benefit, or those projects that seem to lumber along with no end in sight, these are all examples of the status quo bias.

More importantly, it’s one of the reasons that people stay in dead-end jobs and poor relationships instead of finding something better. The pain isn’t too bad. It’s sufferable. And so, as our founding fathers recognized, we hesitate to implement a substantial change.

There’s a reason they’re called dead-end jobs. Because while you work and work and work, things don’t change. And whether it’s a job, relationship, project, or hobby, the end result is the same — it’s preventing you from doing something more meaningful.

Instead of being content to accept things as they’ve always been done, focus on stopping those things you wouldn’t start. Ask yourself:

Would I be willing to accept this job, or start this relationship, or join this project today? Would I be willing to implement this process or schedule this meeting now?

If it were a decision to start something you are already invested in, would you? If not, why should you keep doing it? As Bob Iger put it,

“The riskiest thing you can do is just maintain the status quo.”

Recognize Your Biases and Take Action Today

“First, never underestimate the power of inertia. Second, that power can be harnessed.” — Richard H. Thaler, Nudge: Improving Decisions About Health, Wealth, and Happiness

It’s easy to recognize when someone else is following a doomed strategy. And it’s usually obvious when someone else can’t seem to recognize the warnings of a fast-approaching dead-end. Yet while we’re quick to recognize these issues with others, we’re much less adept at applying that same objectivity to our own lives. Despite the evidence to the contrary, too often we forget about our own blind spots.

None of us are exempt from these biases and fallacies. Our brains are constantly at work to protect us from loss, validate our prior decisions, and promote the safe, predictable status quo. A path that, left unchecked, will encourage us to squander our limited resources and distract us from those opportunities to make a real impact.

The key is to recognize and manage them. Take an objective view and reframe the situation to separate out your biases. And ask yourself, what’s the expected value of this action?

At least before you end up standing in front of a crowd of people, comparing your role in preventing a school development to that of a World War II hero.

Thanks, as always, for reading. If you enjoyed this or have any suggestions, please let me know your thoughts. I’d love to hear from you. And if you found this helpful, I’d appreciate if you could help me share with more people. Cheers!

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