What Are Sunk Costs?
Just because you spent money on something doesn’t mean it still has value. Learn when it’s time to cut your losses.
A version of this article originally appeared on Learnvest.com.
Picture the scene. It’s the evening of the Lady Gaga concert/Yankees game/yoga bootcamp. You bought the tickets months ago, saving up and looking forward to it. But tonight, it’s blizzarding. And you’ve had the worst week and are exhausted. And nothing would make you happier at that moment than a hot chocolate and pajamas, not even 16-inch pink hair/watching Jeter/nailing the dhanurasana.
But you should go, anyway, right? Because otherwise you’d be “wasting your money”?
Think again. Economically speaking, you shouldn’t go. Welcome to “sunk costs.”
In A Nutshell: People Are Bad At Cutting Their Losses
“Sunk costs” is the economic principle that what you have spent is already gone. In other words, you can have spent $200 and have an unpleasant evening, or you can have spent $200 and have a great evening. Either way, you’ve already spent the $200.
Robert Leahy, a psychiatrist and Director of the American Institute for Cognitive Therapy in New York, says, “A model of good decision-making is always based on future utility or future payoff. For example, a woman goes out and spends $300 on a dress and at home tries it on again but it doesn’t fit, she looks awful in it. She may be reluctant to get rid of it because she may think, ‘Oh my god, I put all this money into it!’ She’s honoring the sunk cost.”
More often than not, people will waste money (and time) in order to justify costs they’ve already spent–it’s like throwing good money after bad. It applies to not only financial decisions, but professional and relational ones as well.
Know When To Bail
One of the smartest moves we can make for our money and time is to know when to cut our losses. The irony of a sunk cost is that the more we have put into it, the harder it is to abandon it.
The first key is to recognize a sunk cost. Leahy advises, “Ask yourself, am I staying with this relationship or at this job, computer, house or this piece of clothing because I’ve already put money into it? That’s sunk. That’s all down the drain. If I had never made this commitment, would I go out and get it now? If the answer is no, then you probably should try to get rid of it as soon as possible.”
According to Leahy, it’s also important to know when to bail because of missed opportunities. “If I stick with this commitment to this past relationship, car, or house, am I losing out on other opportunities?” says Leahy. Your money and time can be better spent on new experiences you may not be as open to when you’re hanging on to old things.
How to apply the principle of “sunk costs” to your life:
- Walk out if the movie is bad–your ticket is already a sunk cost. Do something fulfilling with those two hours: take a walk or enjoy a book over a cup of coffee.
- Don’t read those magazines if you’re not enjoying them–the subscription is already a sunk cost. If your time is better spent on a hobby, do that instead. And make a note to yourself not to renew.
- Consider selling a flagging stock and declaring your losses–just be sure to talk to your accountant about the best times to do this (usually end of year).
- Go through your closet (and house) and donate or sell expensive items you are no longer using–their purchase is a sunk cost, and holding onto them just because they were expensive may make you feel less guilty, but is not the best decision for you.
- End a relationship if you feel it isn’t going anywhere (friendship, romantic relationship)–the time you spent is already a sunk cost. You’ve probably learned valuable things, so don’t see it as wasted time, but not every relationship is meant to move forward.
Do a Sunk Cost Inventory of Your Life
Humans aren’t rational by nature, and that’s why so many businesses rely on subscription or pre-paid models, so that we feel “invested” and force ourselves to partake of their product or services. Be savvy to this. Start with these three steps:
- For the next month, start living by the “sunk costs” principle. Let things go and let money “go to waste” if you’re not really enjoying the things you’ve invested in.
- Keep track of how much money you have spent on things that are not bringing you enjoyment or fulfillment.
- See how much money you can save if you cut some of these things out of your life.
Do this for small-ticket investments like package classes, subscriptions and items you’ve purchased, as well as big-ticket investments like house, car, job and relationships.
The principle of sunk costs isn’t about living a life without commitment or follow-through. There are things we may not feel like doing in the instant but we know deep down are good for our well-being (exercise and healthy habits are just one example, and all worthwhile relationships require hard work).
But it is about getting in touch with what we truly want now, not what we think we have been wanting all along. It’s about spotting our own patterns in honoring sunk costs, and making better decisions in the future. Clearing the sunk cost “baggage” (financial and otherwise) from our lives will make room for better things. Because sometimes walking away is the wisest decision we can make.
-Written by Maria Lin
Related links from LearnVest:
- Financial Frenemies: Who’s Your Budget Buster?
- How to Splurge Right
- Sign Up for LearnVest’s Debt-Diminishing Financial Bootcamp