One of the best pieces of economic advice I know is ”Don’t throw good money after bad”. Or in other words, when you consider whether you should continue to invest in a project, don’t let the sum you’ve already invested figure into your decision. To do so is known as the ”sunk cost fallacy”, and leads to ”escalation of commitment”. A good way to avoid this is to decide beforehand what your exit conditions will be, and then stick to them. A bit like saying “I’m going to play the slot machines until six o’clock or until I’ve lost $50, whatever comes first”.
Google Maps offers a beautiful real-life illustration of this. It’s particularly instructive because unlike the case with your financial investments, this software can tell you with a high degree of accuracy what the outcome will be if you escalate your commitment – and if you don’t.
I’ve never had a dedicated satnav in my car. My route planning has always been “look at the map, find the shortest path, see if any major highways are near that shortest path”. But recently I’ve begun using Google Maps. I tell it the endpoints of my trip and the means of transportation I’m using. It computes a couple of itineraries and tells me how long each is likely to take. “Path A is the fastest and path B will take 17 minutes longer”. I then start driving along path A. I invest in it.
Now, I don’t check Google Maps continuously. My smartphone is not in a dashboard holder and I have no lighter cable for powering it. I check the status of my investment maybe once every two hours of driving, or when I get the feeling I may have taken a wrong turn. And sometimes in unfamiliar territory I find that I have indeed veered off path A. Should I retread my tracks and get back on that path? I ask Google Maps again.
The software has no memory of recommending path A to me. It has no sense of commitment whatsoever. It just knows where I am now and where I want to go. So in many cases it tells me “Path C is the fastest. You could take the later stages of Paths A or B instead, but that would take 10 and 13 minutes longer, respectively.” Escalated investment in my original project would clearly just be stupid. I chose path A at the outset because I trusted Google Maps, so why shouldn’t I trust it now that I’ve left that path? On the strength of new information, I invest in path C instead.