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How to Understand and Overcome the Sunk Cost Fallacy

One of the biggest bars to making the best financial decisions is our own mental resistance to logic. That’s not a shortcoming, it’s what keeps us from being Vulcans. I even think that a less-optimal financial choice that you actually stick with may be better than the optimal one, if it’s hard for you to do.

But there are times when we need to work to overcome our illogical tendencies in order to make good decisions. I think Plonkee (she also references blunt money in coming to this) has hit upon a great solution for overcoming the sunk cost fallacy.

She provides a defintion of the sunk cost fallacy that I like — “Once you’ve irrevocably paid for something you should take that into account when considering what to do next.” It’s throwing good money after bad.

This leads to people paying for more tennis lessons even though they hate tennis, because they’d hate to see the money wasted. Or people hold onto bad investments because they bought them in the first placce. Or people risk their lives to see a basketball game because they’ve got tickets and the money would be wasted if they stayed home because of the bad weather.

On the outside, we can see the illogic in these actions, but when you’re inside of them it’s hard not to get emotionally involved. So Plonkee suggests picturing what you’ve sunk your money into as a gift, or even a found item.

If you found a pair of shoes which didn’t fit right, would you keep wearing them? If you were given basketball tickets but then there was a snowstorm, would you still go? If someone gave you a stock which was clearly tanking and probably wouldn’t go back up, wouldn’t you sell while you still could?

The money you put into the item is gone (unless you can come up with a way to sell it) and all you’re left with is the item. Use the mental energy that’s trying to get you to hold onto a lemon before you buy. Spend time thinking about whether or not you’ll regret it, whether you’ve done so in the past, whether this is a good deal. But once you’ve bought, let that rest. If you find yourself trying to come up with reasons to use it “even though x” then imagine it as a gift and rethink those reasons.

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{ 7 comments… read them below or add one }

the weakonomist March 31, 2009 at 7:24 am

There are many things around me that are the result of the sunk cost fallacy. The first thing that comes to mind are a bunch of work clothes I’ve rarely worn because they don’t fit or I don’t like them.

Even our government has a problem with this. AIG is the world’s largest sunk cost fallacy.

Small Steps to Health March 31, 2009 at 10:33 am

It is also just like the dieting mentality. People hate going on a dieting and rarely does it work without yo-yoing, and yet people keep doing it. I think it is all about educating people that just because you are in a habit to “sink” time or money into something does not mean that you always have to do it. You always have the option to stop dieting or to stop taking tennis lessons. If a path is wrong for you, throwing more money at it rarely makes it right.


Ken March 31, 2009 at 2:25 pm

As I am disappointed about current investments that are far from what I wanted at this place in time, I choose not to withdraw it all and put it in a CD. I do have the benefit of time before I reach retirement. Sometimes you have to see the bigger picture. At the same time if an expense is not justified or desired anymore I think it’s OK to pull the plug on it.

Diane March 31, 2009 at 3:29 pm

This is a painful lesson. The feeling of having bought something that doesn’t work out or continues to cost more than it is worth is hard to deal with.

Sometimes is just best to cut your losses & move on. If something makes me feel bad every time I see it and I’m not using the item I will just get rid of it. If you’re lucky you can sell it and make a few dollars back, but if not it’s better to donate it and move on.

I refuse to keep things that make me feel bad!

This does make me think very carefully before making a purchase. I am very cautious about spending money until I’m sure about what I want now, and I do make far less mistakes.

The downside is the difficulty of making a decision… which can drive other people nuts. But if I’m spending the money I’ll wait until I’m comfortable with the decision, however long that takes.

Sometimes this means I just give up without buying and item, so I probably didn’t need it anyway!

Scott April 1, 2009 at 1:31 am

I’m not sure I completely agree that you should never take the original cost of something into account when making decisions relating to that item.

All items have a current value – a perceived value to the owner. Whether you paid for them, or got them for free, it has a value that can usually be expressed in dollars.

Free basketball tickets? Those are still $120 tickets. That you’re holding in your hand. That is worth $120 to you. It is as if someone put 6 $20 in your hand. If someone offers you $20 for those tickets, you laugh and accuse the guy of thinking you’re crazy.

Did you win a car at a raffle? Same deal, you’re not letting someone buy it on the spot for $100. Doesn’t matter if you already have a car and don’t need another. The car has a value to you even if its free.

So maybe you should ignore what you paid for it, just like stocks that have already gone down, but you shouldn’t ignore its current value. And that’s why people will drive in a snowstorm to see a basketball game when they got the tickets for free.

mrsmicah April 1, 2009 at 6:57 am

@Scott, I think you make a good point. If you’re trying to get rid of something, you should look at its value.

BUT, that said I don’t think that the baseball tickets are worth $120 unless you can find someone who’ll pay that for them. Because if you don’t want them and nobody is offering $120, then $20 might be your best deal to come out ahead. After the game, they won’t be worth anything.

The problem with sunk cost fallacy is that, among other things, you’ll be thinking that they’re worth $120 when that could be true but it isn’t necessarily so.

fathersez April 16, 2009 at 12:41 am

The same logic when applied to bigger ticket items is even more painfull.

Like a Timeshare and a club membership.

Hardly used and yet we had to pay yearly and monthly fees. The best was to cut. The monetary gain was no more charges / fees. The loss was the pain of the foolishness in getting them in the first place.

fathersez’s last blog post: A part of whatever you earneth, the taxman taketh

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