Imagine you bought house A for $500,000 in 2008, and your friend bought an identical house (next door neighbor) house B for $300,000 in 2011.
Both of you are planning to sell your houses, you both believe that house prices will not change in the coming 5 years, and you both get identical offers from 2 buyers for $400,000.
Whose decision is easier? I bet that you would have to think a lot harder about selling your house "at a loss", while the decision would be far easier for your neighbor, who's realizing a "gain".
But here's the problem with your thinking process: the house is worth $400,000 today, will be $400,000 1 year from now, 2 years from now and 5 years from now. It doesn't matter what you paid for it, your decision should be based on what you can sell it for. You cannot go back and change the past.
I learned that early on in my career when I was a young and ambitious stock trader and struggling with the decision to sell a stock that has gone up in price. So I came up with a question I would ask myself, and the response to which would drive my decision to "hold" or "dump" the stock: "would I buy this stock today if I didn't own it?". In the VAST majority of cases, the answer would be "NO", and so I would sell the stock.
That's one that most traders struggle with, because the temptation to hold onto a stock that's "doing well" is very strong.
Psychologists call this "Sunk Cost Fallacy": making decisions based on "what you've already invested" into a situation, regardless of the "merits of the situation itself".
But don't think that the Sunk Cost Fallacy applies to a business environment only: we often fall prey to that same fallacy in relationships, friendships, money spent on courses, purchasing cars or houses, etc... We develop a strong "emotional attachment" with a situation/relationship/object just because we spent considerable resources on it, even if the outcome of the situation/relationship/object is probably negative.
I sometimes face this problem with very talented entrepreneurs: I look at their business and it's clear to me that it's not viable "from a business point of view" - it's a great product, but for the wrong market, or at the wrong cost, etc. This talented entrepreneur has a very hard time accepting defeat and moving on to try something new; not because they still believe in their product (often a bit of prodding unveils a realization which was already there), but because "they've dedicated 3 years of blood, sweat and tears" to this venture.
But the bottom line remains: "the business is not viable", it does not matter how much work you put into it in the past, it doesn't change the fact that "it's not viable".
I'll give you a common non-business example:
This one may sound harsh, but unfortunately the alternative is often worse:
You're in a relationship with someone for 8 years. You've had your ups and downs, and there have been more "downs" than "ups" in the last 2 years. You're tempted to walk away but you don't, because "you've invested so much into this relationship! 8 years of your life!".
Let me ask you this: is the "duration" of the relationship going to provide you with the solutions to the "core" problems in the relationship? If your partner is being unfaithful, uncaring, disengaged, does the fact that you've been together for 8 years make him/her more likely to change vs. if you were in that relationship for 2 years?
Don't get me wrong, if the problem is "lack of effort" and you BOTH feel that you've invested so much that you BOTH use that "history" as a motivator to "work harder", then maybe, but the majority of cases reviewed by behavioral psychologists point to one obvious conclusion: the Sunk Cost Fallacy often stops us from achieving our best by introducing an "illogical factor" into our decision-making.
So the next time you make a major decision - whether about buying something, starting a business, staying in a relationship - ask yourself: am I making that decision based on "what I already put into it / paid for it? or am I making a decision based on ITS PRESENT and FUTURE potential?"
What do you think?