The trick to learning when to cut your losses….

A gambler might call it chasing your losses. The British saying – ‘don’t throw good money after bad’ – captures a similar sentiment. Economists call it the sunk cost fallacy, and it’s ubiquitous.

What links these examples is the phenomenon of continuing to throw good resources (time or money) after bad, hoping for things to improve when there’s no good reason to believe they will.

In other words, people are loath to cut their losses. We are much more likely to continue to senselessly plough time or money into a project that isn’t working out, in the hope that it will get better, than take a hit and walk away. What drives this is optimism (that, against the odds, the situation will improve) and an aversion to failure.

At work, the consequences of desperately hanging on to irrecoverable costs can be catastrophic. For smaller firms, this could mean, for instance, putting off firing a worker you have spent months training, even though it was clear from the outset they were never going to cut it.

But this same spirit pushes people towards totally illogical huge investments. Thinking only in terms of future possible gains means they fail to factor in unrecoverable funds already spent. It’s easy to see why.

After you’ve invested £10 million ($13m) in a project, which hasn’t delivered, the case for throwing in a further £5 million is far easier to justify if you only consider returns on £5 million – rather than £15 million. But in reality, of course, you also don’t want to look stupid by abandoning it.

Making continuous foolish decisions driven by sunk-cost analyses will eventually lead firms to haemorrhage money or market share and consequently grind to a halt.

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