One tweet mourning the passing of singer Pete Seeger last month came from behavioural economist Richard Thaler, co-author of the bestseller Nudge. Thaler advised that we listen to one of Seeger’s tracks called Waist Deep in the Big Muddy – which he described as the “best song about the sunk cost fallacy.”
Seeger wrote the song in 1967 and it was initially censored on US television because of its content – a story about an army captain who orders his platoon to wade into a river despite the reservations of his more cautious sergeant. Although the song was allegedly about an incident in 1942, many considered it symbolic of the US’s involvement in Vietnam.
“Waist deep in the Big Muddy And the big fool says push on…”
The sunk cost fallacy is the mistaken belief that it is sensible to continue with a plan of action once it has been started, given time and money have been spent. It is a common behavioural bias often witnessed in government projects, military strategies and corporate endeavours – because human beings do not, as a rule, like to admit they were wrong. It is hard to abandon real and emotional investment, even in the face of mounting evidence. Sunk costs, in author David McCraney’s words, “drive wars, push up prices in auctions and keep failed political policies alive.”
The sunk cost fallacy is sometimes known as the Concorde fallacy because the first supersonic airline project, subsidised by Anglo-French governments, haemorrhaged money from the start. The beauty of the plane made emotional investment easy, but eventually the money ran out.
In financial markets, the sunk cost fallacy is seen on many occasions. Prospect theory, formulated by economists Daniel Kahneman and Amos Tversky, reminds us that investors are not always good at accepting, let alone crystallising, losses. It does not seem an unreasonable strategy to buy more at a lower price, assuming the fund manager remains convinced (provided that previous investment does not distort their estimate of true value). Nevertheless, many a pension fund portfolio contains stocks that are deep underwater. A good question for a trustee to ask their portfolio manager in such circumstances is “would you buy this stock today, given a blank sheet of paper?” If the answer is a no, the conversation could get interesting.
One simple piece of advice offered by Gary Belsky and Thomas Gilovich in their excellent 1999 book Why Smart People Make Big Money Mistakes is: “Forget the past. We don’t want to sound too New Age here, but very often our decisions about the future are weighed down by the actions of the past… we hold on to bad investments because we can’t get over how much we paid for them and can’t bear to make that bad investment final. Well, get over it.”
The most obvious inability to accept reality, indeed to keep throwing good money after bad, is a government that tries to defend an indefensible currency peg or exchange rate in the face of worsening economies, deteriorating balance of payments deficits and rising unemployment – think the UK in 1992, Mexico in 1994, Thailand in 1997, Russia in 1998, Argentina in 2002… the list goes on.
And only last month, the Turkish lira appears to have succumbed to the Big Muddy.
With hindsight, it is often easy to label the sunk cost as hubris or stubbornness but it is important to remember that the sunk cost fallacy can subconsciously affect genuine, well-meaning, people, many of whom are generally good in their modern-day roles. Most of our biases, however, may be hardwired into us over millions of years for perfectly good evolutionary reasons.
Originally published in Financial News, February 10th 2014.