Beware of Sunk Costs

Imagine you paid twenty dollars for a ticket to a local amateur play.  The day of the show, a friend surprises you with a free ticket to an exclusive concert featuring your favorite musician.  Do you choose to go to the play or the concert?  When behavioral economists run this type of experiment, they find most people will stick to the less attractive option (the play) because they paid for the ticket.  This is an example of the sunk cost fallacy in action.

Our minds are easily trapped by sunk costs.  According to Investopedia, a sunk cost is a cost that has already been incurred and thus cannot be recovered.  While this concept is often discussed around investments of money, sunk costs also include time and resources.  Think of how often an organization will add patches to clunky system instead of ditching it to build a new one.  People will stubbornly remain committed to a project that is going nowhere because of all the work put into it, even if results remain elusive.

dollarsandsenseRemember, a sunk cost is not recoverable, which gives rise to the famous expression, “Chasing good money after bad.”  The trick is to evaluate the current status of a project, investment, or commitment in light of where it stands now and ignore past contributions.  This way, it is possible to stay nimble and take advantage of better opportunities when they arise.

More information on sunk costs, especially around money, can be found in the book, Dollars and Sense: How we Misthink Money and How to Spend Smarter, by Dan Ariely and Jeff Kresisler.

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