If you’ve ever watched an entire movie you didn’t enjoy or ate food you didn’t like – just because you paid for them, you’ve experienced the sunk cost fallacy.
In these examples, the money you spent on the movie and food is a sunk cost. The reasoning behind your decisions to watch the movie and eat the food illustrates the sunk cost fallacy.
Sunk costs are an inescapable part of life.
They can become a problem when you use them to justify your decisions, like when you don’t accept that you wasted money or made a mistake.
In this article, we’ll cover what sunk costs are and how the sunk cost fallacy affects your decisions. We’ll also suggest ways to calculate sunk costs to help you decide when to ignore them.
What are Sunk Costs?
Sunk costs are costs you’ve already incurred and cannot get back.
In economic terms, a sunk cost is money you’ve spent, but can’t recover. Sunk costs also apply to time or other resources you spend and can’t get back.
When you can recover time or money spent on something, it’s not a sunk cost. Let’s say you buy an item you don’t want. If you return it to the store or sell it for the same amount you spent, it’s not a sunk cost.
Examples of Sunk Costs
Below are some examples of sunk costs:
- You buy a kitchen appliance and use it for two weeks. You soon realize it’s not all that useful, and it’s just taking up space. You can’t return it. And if you sell it, you’ll get a fraction of the purchase price you paid for it. The money spent on it is a sunk cost.
- You spend hours researching companies and conducting interviews in your job search. The time spent on your job search is a sunk cost (even if you land the perfect job).
- Once you pay rent, the money won’t get refunded. In that respect, your rent is a sunk cost.
- A business pays for market research. Because of the study, the company decides not to release a product. The money spent on market research is a sunk cost.
As you can see, sunk costs aren’t always negative. They can add value and are sometimes necessary costs (e.g., the food you buy and eat). It’s when you fall for the sunk cost fallacy that they become a problem.
What is the Sunk Cost Fallacy?
Sunk cost fallacy happens when you’ve already spent money, time, or resources on something – and you continue to do so even when it no longer benefits you.
Have you ever ordered a meal at a restaurant and eaten your entire platter of food – even though you were full long before you finished? Because you wanted to “get your money’s worth”?
That’s a classic example of the sunk cost fallacy.
Examples of Sunk Cost Fallacy
Here are more common examples of the sunk cost fallacy (that we can all recognize!):
- You continue to put money in a financial investment that’s losing money. You hold on to hope it will recover one day. That’s what the phrase “throwing good money after bad” means.
- You keep things (i.e., clutter) you no longer want, need, or use because you spent money on them.
- You stay at events you bought tickets for (i.e., movies, concerts), even when you don’t enjoy them.
- You spend time, money, and energy on a failing business. It’s not growing in line with your projections, and you’re continuing to lose money (and time). You stick with it because of the time and money investment you’ve already made in it.
- You invest time and emotional energy into an unsatisfying relationship. You’re not happy, and you don’t see the relationship improving. But you continue in the relationship because you’ve already invested so much.
Why Do We Fall for the Sunk Cost Fallacy?
The sunk cost fallacy interferes with reasoning because, as human beings, we 1) overthink and over rationalize things, and 2) have an emotional investment in our past decisions.
Essentially, we let emotions prevail and interfere with decision making.
The reasons we fall for the sunk cost fallacy are:
- We don’t want to admit we’ve made a mistake. We continue doing something to prove our initial decisions were “right.”
- We don’t want to feel wasteful. Once we’ve put time, money, and energy into something, we feel the need to persevere, even if it’s futile and leads to unhappiness.
- We don’t like to lose (loss aversion). Once we have something, we don’t want to lose it, so we do what it takes to keep it. On the other hand, once we’ve experienced a loss, we put more in to try to recoup losses.
These reasons signal our attachment to sunk costs. We often continue to invest in them to avoid loss, shame, or change in our lives.
As you can see, it’s easy (and natural) to fall for the sunk cost fallacy. But by being aware of it, you can keep this irrational decision making in check to make better decisions.
How to Calculate a Sunk Cost
When you calculate a sunk cost, it can prevent you from putting more money, time, or energy into something that no longer gives you value.
It’s crucial to forget about the past and think about what’s happening right now.
To calculate a sunk cost, go through the following process. Please write it down! And, when making a financial decision, do the math.*
- Forget entirely about the past. Disregard your past investment of time, money, and other resources.
- What will it cost you to continue to invest?
- What do you want or need right now?
- If you continue to invest, will it give you what you want or need right now? Or will it lead to further losses?
- Would you be better off in the not-so-distant future if you reverse course? (Even if it means you experience short-term discomfort?)
- Make a pros/cons list if you need to weigh the decision further.
Let’s say you paid $500 for a car repair two months ago. Now you need significant repairs costing $2000. Since you recently spent $500, it’s tempting to think of that $500 as a waste of money – if you don’t do the $2000 repair.
But, to make the most informed decision, forget about the $500 repair. That expense is in the past, and it has no bearing on whether you do the $2000 repair.
The new repair estimate of $2000 is the only relevant cost to consider now. You need to decide if you want to spend that amount now to repair your car – or do something different.
To figure this out, determine your current transportation needs. Then, decide if you should spend the $2000 for the repair, buy a different car, borrow a car, rideshare, or take public transportation.
Finally, make a pros/cons list for paying the repair cost versus other options.
*We cannot calculate relationships. It’s generally pretty straightforward to calculate sunk costs with financial decisions. But, when you’re considering the sunk costs of a relationship, the decision should be more difficult. In these situations, we recommend seeking professional help.
When to Ignore a Sunk Cost?
Because you can’t recover sunk costs, they’re often irrelevant to current and future decisions. You can’t go back and change the initial decision, so it doesn’t hold value with current decision making.
Ask yourself some questions.
Here are some further questions for reflection when trying to decide whether to ignore a sunk cost:
- Suppose you were to start over at the beginning of your decision-making process. Would you make the same decision again?
- Are you giving up other opportunities to continue with the status quo, simply because you made a commitment a long time ago?
- Have things changed since you made the initial decision, making it less beneficial?
- Do you have more information now than you did when you made the initial investment? Does this information impact that decision?
- Are you afraid to admit you were wrong? Do you (unhappily) stick with a decision, even though you realize it was a mistake?
- Would you tell a close friend or relative to make the same decision?
- Are you trying to avoid the discomfort of change in the short term? Try to think of the long-term consequences.
You should generally ignore a sunk cost and avoid further investment unless it shows convincing evidence of providing current and future value.
Sunk costs are a fact of life. And it’s human nature to fall for the sunk cost fallacy from time to time. Yet, you can learn to identify and calculate sunk costs and try to avoid the sunk cost fallacy.
Once you know how to recognize sunk cost fallacies, you can make better financial and life decisions.
Article written by Amanda