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The gamble offers the chooser the opportunity to inject luck into the equation, turning a sure thing into a more uncertain short-run outcome.
That difference exposes an asymmetry in when we want to walk away and when we want to gamble. When we are in the gains, we don’t want to recruit luck into the equation, luck that might wipe out what we have already won. We want to quit while we’re ahead.
But when we have already accrued losses on paper, we become risk seekers. Daniel Kahneman subsequently characterized this as sure-loss aversion.
Given these findings, let’s amend our quitting aphorism to say: Quitting on time usually feels like quitting too early, and the usually part is specifically when you’re in the losses.
Quit While You’re Ahead?
Occasionally, quitting while you’re ahead is, of course, reasonable advice, specifically when you have managed to win at something that is a losing long-run proposition. Like baccarat or craps.
(I hope it’s becoming very clear how bad the advice “quit while you’re ahead” really is, because it’s encouraging our natural tendency to be irrational in these situations already.)
In a 2015 paper, Henry Farber, an economist at Princeton, looked at data on cab driver behavior spanning 2009 to 2013. He found that veteran drivers, while not perfect, did make better decisions about when to keep driving and when to quit than newer drivers.
The researchers looked at data from sophisticated market participants, over seven hundred institutional portfolio managers, with average assets under management valued at nearly $600 million. Not surprisingly, they found that expert investors’ decisions about
what to buy performed much better than a benchmark that just indexed the market. The average stock purchased by these portfolio managers outperformed the benchmark by more than 120 basis points, annualized (or 1.2 percentage points).
The advantage these experts have in buying equities isn’t mirrored when they sell them. While they’re earning 120 basis points in excess returns on their buy-side decisions, they’re losing 70 to 80 basis points, annualized, on their sell-side decisions. That means they would be better off if they just chose randomly from their portfolio to decide what to sell.
Rather, they tended to sell stocks only if they were either extreme winners or extreme losers in the portfolio.
A key finding of prospect theory is loss aversion, the phenomenon whereby the emotional impact of a loss is greater than the corresponding impact of an equivalent gain.
When we are in the losses, we become risk seekers. We want to keep going, hoping we can avoid ever having to realize the loss. Daniel Kahneman has characterized this as sure-loss aversion. In other words, we like to stick when we’re behind.
Quitting on time usually feels like quitting too early, and the usually part is specifically when you’re in the losses.
escalation of commitment
Once the United States got into Afghanistan, it took twenty years to get out, despite three different presidents promising to do so.
Staw’s central insight about escalation of commitment is that the phenomenon is not confined to matters like the Vietnam War, a complex geopolitical conflict with national pride wrapped up in
When we are in the losses, we are not only more likely to stick to a losing course of action, but also to double down. This tendency is called escalation of commitment.
Richard Thaler, in 1980, was the first to point to the sunk cost effect as a general phenomenon, describing it as a systematic cognitive error in which people take into account money, time, effort, or any other resources they have previously sunk into an endeavor when making decisions about whether to continue and spend more.
A perfectly rational decision-maker would consider only the future costs and benefits in deciding whether to continue with a course of action. In other words, if continuing on has a positive expected value, a rational actor would persevere. If it has a negative expected value, they would quit.
Forty years of experiments and fieldwork across a variety of domains show that people behave as Thale...
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costs. In decisions about whether to move forward, they do take into account what they’ve already spent. They do this because they irrationally think that the only way to reco...
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If you’re like most people, your gut tells you there is a difference between these two scenarios. In the second case, people are much more likely to choose to go, because they don’t want to waste the ticket that they have already bought.
If you decided that the costs of going outweigh the benefits when offered a free ticket, then that means the costs of going also outweigh the benefits when you have already purchased a ticket.
And the effect is stronger the more the ticket costs. Imagine if, instead of $95, you had spent $150 or $250 or $500. As the price tag grows, so does the effect of sunk costs.
a decision to hold is the same as a decision to buy.
In addition to the direct costs of the project, there is the issue of opportunity costs.
Ironically, bloated past costs became the justification for not abandoning the project.
It’s easy to look at these fiascos, roll your eyes, and think, “Typical government waste.” But the sunk cost effect makes us all, in ways big and small, build a track from nowhere to nowhere, refusing to quit because we don’t want to lose what we’ve already spent.
There’s a saying among top poker players that poker is one long game.
When we start something, whether it’s putting money into the pot in a hand of poker, or starting a relationship or a job, or buying a stock, we open up a mental account. When we exit that thing, whether it’s folding a hand, or leaving a relationship or job, or selling the stock, we close that mental account.
It turns out that we just don’t like to close mental accounts in the losses.
Eric Teller
Udacity,
X has become a famous incubator and developer of ideas in the nontraditional tradition of Bell Labs, Xerox PARC, and Thomas Edison’s laboratories. X’s mission is to build and launch technologies to “improve the lives of millions, even billions of people.”
“10x impact on the world’s most intractable problems, not just 10% improvement.”
His paternal grandfather was Edward Teller, the legendary physicist who was one of the inventors of the hydrogen bomb.
Once a project reaches the point where it is polishing its product or scaling operations, it “graduates” from X. X’s most famous graduate was one of its first projects, a self-driving car. In 2017, it became Waymo, an Alphabet company.
Teller looks at each project as buying an option on the future. Like most options, you have to keep paying to hold it, in increasing amounts.
Imagine that you’re trying to train a monkey to juggle flaming torches while standing on a pedestal in a public park.
The bottleneck, the hard thing, is training a monkey to juggle flaming torches. The point of this mental model is to remind you that there is no point building the pedestal if you can’t train the monkey.
In other words, you ought to tackle the hardest part of the problem first.
One of Teller’s valuable insights is that pedestal-building creates the illusion of progress rather than actual progress itself.
We can see this illusion of progress that pedestal-building creates with the California bullet train. We’ve built countless miles of train tracks over flat land everywhere.
Figure out the hard thing first. Try to solve that as quickly as possible. Beware of false progress.
If we can identify in advance what the signals are that we should pay attention to and make a plan for how we will react to them, we can increase the chances that we’ll cut our losses when we ought to.
“What are the signs that, if I see them in the future, will cause me to exit the road I’m on?
kill criteria,
One of the clearest examples of a kill criterion is the turnaround time on Everest.
