Back in high school, I took an art class my sophomore year. Drawing and sketching were one of my favorite hobbies growing up. I always gravitated towards classes where I could one or both.
One of the projects we worked on was a self painted portrait. This portrait was painted on canvas. It started with a pencilled sketch. Once we started to figure out the dimensions and color scheme, we started to add layers of paint. Layer by layer, the portraits started to come to life. Well – at least that’s what the plan was.
Ryan was one of my good friends that I sat next to in class. We took a couple of different art classes together. While I grew up thinking I was pretty good at art, Ryan made me reconsider my talents. Everything he touched – whether it was pen, pencil, or paint – was just better than what I did. It was eye-opening, but important. Whenever I felt stuck or couldn’t bring an idea to life, observing what he did helped give me ideas. It was a ton of fun to watch him work.
One day, I walked into class. It had been about a couple weeks since we were working on our self portraits. I showed up eager to polish off some finishing details on my piece. I was finally starting to like what I was putting on canvas. Ryan, however, was not.
When I walked into class that day, I saw Ryan doing something odd. He wasn’t working on his self portrait. He was erasing it. He covered his entire portrait in white paint until you couldn’t see anything anymore. Everything he had worked on in the past several weeks had been erased in a few minutes. While most of the kids in our class were finishing their portraits, Ryan decided he didn’t like what he had put together. He was starting over.
When it happened, I wasn’t just shocked. I was blown away. Ryan was one of the most talented kids in our class. He had already put together something that far exceeded the rest of the work from the class. What we all saw, however, did not match what Ryan saw. What looked like a really good piece of art was just not up to standard for Ryan. He wasn’t willing to submit he wasn’t proud of. He would rather start over. Sure enough, it only took a few short classes to polish off a piece that surpassed his original draft.
It took me several years to appreciate the significance behind this decision.
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Let’s pretend you’re out to dinner. Knowing you’re pretty hungry, you decide to order a big plate of shrimp linguine pasta. It’s your favorite. By the time your pasta dish comes out, you’re already had a couple of helpings of bread (we’re all guilty). It takes just a few bites to realize how big of a challenge it’s going to be to finish your linguine.
You’d normally just grab a to-go box and finish it later, but you fly out of town tomorrow morning. Anything you don’t finish today won’t be any good when you return home. As a result, you press on. Fifteen bites later, you feel like your stomach can’t hold anymore. Here’s the problem: Your dish is still half full. When you get the bill, you’re not going to be happy about paying full price for a half eaten dish. You decide not to let this happen.
Over the next 20 minutes, you labor and pick off noodle by noodle until just a small fraction remains on your plate. You pay the bill and leave the restaurant, only to be stuck in the midst of a serious food comma. What started as an enjoyable meal ended up turning into force feeding. No one made you to do it, either. You only have yourself to blame, and now your stomach has to pay the price.
I used this situation because it’s a familiar one. We’re all guilty of eating more than we should because we’re worried about spending money on food we didn’t eat. It seems smart from a microeconomics perspective. The problem becomes when we look at the macro. It’s actually quite detrimental. Making the decision to scarf down more pasta isn’t just about pasta. It’s about making conscious decisions that decrease the quality of our life.
Every one of our actions has a consequence. The most innocent ones can have the most sinister effects down the road. What tasted so good at one point lost it’s flavor because we never made the decision to stop eating.
Just imagine when you learn favorite baseball team is forcing too much “pasta” down their throats (hint: it’s not pasta).
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Sunk cost fallacy – as proposed by Daniel Khaneman and Amos Tversky in their best-selling book Thinking Fast and Slow – is a cognitive bias created when our perception of value does not match actual added value. We do something because we paid for it – not because it’s valuable to us. This asymmetry is influenced by personal investment. If we invest time, energy, or money into something, it gains perceptual value. The more we invest into it, the more valuable it becomes to us. This is the problem. Just because we have a large investment at stake does not mean there’s a large amount of value attached to it.
If you’ve ever had a tough time walking away from a big project or selling a bad investment, you’ve suffered from sunk cost. Dropping the project or selling at a loss admits a waste of resources. Our inputs don’t match our outputs. While it’s a tough pill to swallow, it’s a necessary one for cutting future losses. The longer we fall victim to sunk cost, the more we lose out on in the long term. Most people don’t figure this out until it’s too late.
The decision to keep eating the pasta in the story above is the perfect example of sunk cost. You don’t go out to eat to throw yourself into an unenjoyable food coma. You do it to enjoy a nice meal. The decision to eat more than we could handle was an irrational byproduct of loss aversion. We were worried about losing out on what we were going to have to eventually pay for. The more food we waste, the more our money goes to waste. We’re not evaluating our decisions based on the value they bring us. We’re evaluating them based on our perception of what we lose out on.
We didn’t eat the rest of the pasta because we wanted to. We ate it because we paid for it. This is sunk cost thinking, and it happens in a lot more places than restaurants.
Back in 2012, the Los Angeles Angels signed Albert Pujols – nine time All-Star and 3X MVP – to a 10 year $240 million contract. At the time, Pujols was arguably the most feared hitter in all of baseball. He finished top three in the MVP voting eight out of his first nine seasons. He didn’t have a season where he hit less than 32 homers, hitting more than 40 in six. In his 11 seasons with the Cardinals, he slashed a remarkable .328/.420/.617. He could have gone 0-528 the next season and still had a career batting average north of .300. It wasn’t just impressive. It was completely unheard of.
Since signing with the Angels, however, Pujols has been anything but impressive. Over the past 10 years, Pujols slashed .256/.311/.448. His lifetime batting average dropped 27 points, currently sitting at .297. Over the first 11 years of his career, Pujols belted 445 homers. The past 10, he’s hit just 234. He hasn’t accumulated an OPS north of .800 since 2012. As a Cardinal, his OPS never fell below .906. According to Fangraphs, Pujols hasn’t posted a positive WAR value the past five seasons. Prior to 2012, he didn’t post a WAR south of 3.9.
Despite the clear decline in performance, Pujols has been a consistent staple in the Angels lineup. In 2017, his worst season to that point, Pujols slashed .241/.286/.386. He punched out 93 times – the most since his rookie season. His OPS totaled just .670, recording a career-worst -2.0 WAR. He came to the plate 593 times.
Pujols’ continued presence in the lineup is a classic case of sunk cost fallacy. Over the past five seasons, he has performed worse than the average replacement player. He hasn’t batted .250 since 2016. His slugging percentage hasn’t surpassed .500 since 2012. He’s appeared in one All-Star game (2015) after making nine appearances his first 10 seasons. This didn’t stop the Angels from feeding him consistent at-bats in the top third of the order. The only thing that really kept him out of it was health.
Continuing to bat Albert Pujols wasn’t a strategic move. It was aversive. The Angels weren’t willing to part ways with a really poor financial investment they made. It’s not to say he didn’t make positive contributions to the team over the years. He just didn’t perform to standard. When his performance took a plunge towards the back half of the deal, the Angels were faced with a difficult decision. Should they bench him? Trade him? Or keep playing him in hopes he figures it out?
Pujols had a track record of success. He was in the midst of one of the biggest contracts in baseball. He’s destined to becoming a first-ballot Hall of Famer. He is the one percent of the one percent. Parting ways with a talent of his magnitude is not an easy decision. It’s very difficult. You’re leaving a ton of games, money, and unfulfilled expectations on the table. It’s only human to weigh what we lose more than what we gain.
Ryan’s story is our antidote to this.
The Angels aren’t the only big league team that’s hung on to a bad contract for too long. Every team has. We’re never going to stop this. Decision making is too complex to draw concrete conclusions on future player performance. The one thing we can do, however, is move on sooner than everyone else. It’s not just important to recognize a bad investment. It’s more important to learn when it’s time to move on from it. This is a competitive advantage. We need to have the courage to start fresh when our investments aren’t generating value. Saving losses on the back end will alleviate on lot more than you’ll ever lose on the front end.
When making decisions in situations that involve a high personal investment, we need to learn how to disassociate. We can’t get married to the time, money, or energy we’ve already put in. That distracts us from making a good decision now. We instead need to be, in the words of Daniel Khaneman, “passionately dispassionate.” Sometimes we need to press on. Other times, we need to learn how to step away. If you’re doing something that is not adding value to your life, you can’t keep saying yes. You need to learn how to say no. Sunk cost burns us when we don’t.
Ryan was able to erase his previous work and start fresh because wasn’t married to his sweat equity. He didn’t let what he had already done blind him from what he wanted to do. His dissatisfaction with what he had done outweighed any desire to hold on to the past. The only way to fix this was to start new. It’s the perfect display of avoiding sunk cost thinking. Ryan wasn’t worried about losing out on what he had already invested. He was more concerned with submitting something he wasn’t proud of. This helped him make a good decision.
If we approached our decisions through a similar lease, we’d salvage much more of our losses. This starts by reshaping our perception of a loss. Did we really waste time, money, and energy, or did we simply spend it figuring out what we really wanted? Are we looking at the macro, or are we stuck analyzing the micro? Sure, we know how it plays out if you’re right. But what if we’re wrong?
What would have happened if the Angels decided Pujols wasn’t going to turn it around after 2017? Would they have been a better team? Seen more production out of their lineup? Taken a chance on prospects that were buried beneath Pujols?
The best way to avoid thinking in hindsight is to use foresight. We cannot think for the future if we’re anchored to the past. Become dispassionate about your previous contributions. Get out of your own way. If it’s not valuable, don’t do it. You’ll be better off for it.
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The best lessons are the ones that sting a little bit when we go through them. Being aware of our tendencies to gravitate towards sunk cost helps take some of the sting out of them.
When faced with a difficult decision to move on from something, consider the following questions:
- Am I doing this because it’s valuable, or because I’ve paid for it?
- What am I afraid of losing?
- What would be the benefit of stopping today?
- What could go wrong if I don’t stop today?
Don’t worry about finishing the pasta. Leaving a couple bites is better than taking one too many.