Are you a victim of the 'sunken cost fallacy'?
Throwing Good Money After Bad
by Jan Roland
Could you be making bad decisions because you're paying more attention to what happened in the past than what could happen in the future? Chances are that at least in some areas of your life, you're doing just that.
Don't believe it? See if any of these describe you:
- You have clothes in your closet that you haven't worn in years, but won't get rid of. Your reason? It was expensive, so you should get your money out of it.
- Your email account and browser are full of links to articles that you want to read and videos that you want to watch.
- Your Pinterest account has many boards of things that you'd like to do around the house and crafts that you'd like to try.
- You have a stack of magazines or books that you want to read.
- You have an investment that's slowly losing money, but you don't want to sell.
- You know that your job is a dead end, but you won't leave because of seniority.
- You can't sell your house now because you paid more for it than it's worth today.
If you recognize yourself in any of those situations (or other similar ones), you're a victim of something that economists call "sunk costs." According to Investopedia, "A sunk cost is a cost that has already been incurred and thus cannot be recovered."
All of the examples above are situations where you've invested either time and/or money. Getting rid of the item will be an acknowledgment that you won't get your time or money back.
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"We can think of sunk cost as focusing on the past cost rather than the future utility. You are concerned with what you "paid" for something rather than what you will get out of it in the future. Sunk costs are backward looking decisions." (Psychology Today)
Behavioral economists Gary Belsky and Thomas Gilovich in their book Why Smart People Make Big Money Mistakes state: "This tendency is harmful for the simple reason that past mistakes shouldn't lead you to make future ones. The past is past, and what matters is what is likely to happen from now on."
So how can you avoid throwing good time and money after bad? Watch for these warning signs that your decision making is flawed:
- Your main reason for keeping something is the amount you paid for it.
- You've been meaning to do something with it for a long time and just haven't gotten around to it.
- You'll be able to use it if just a few circumstances occur.
- It's worth less now than what you paid for it, but it's bound to gain value someday.
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You probably can come up with other reasons. They all have this in common. They're looking backwards. It's about what has happened and not what will happen.
Should you care about the sunken costs fallacy? You should if you don't want to waste time or money. At the very least, items like old magazines clutter up your life. At worst, you could allow a losing investment to become worthless. In all cases, you'll spend additional time or money without getting good value for yourself.
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How can you stop falling for the sunken cost fallacy? Be aware of the warning signs that the past is overly affecting how you look at the future. When that happens, force yourself to make an unemotional evaluation of where you are and what you should do to improve your future.
There is no reason to be captive to past bad decisions, and there is no advantage to beating yourself up for them. The best course of action is to learn from them (so you don't repeat them) and then make the best decision for your future.
Reviewed December 2017
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- Learn how to break those bad financial habits.
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