Sunk cost fallacy
Ever found yourself forcing your way through a truly terrible book or a dull TV series? You're not enjoying it one bit, but you think, "Well, I've already invested X hours in this, I might as well see it through."
If this sounds familiar, you've experienced the sunk cost fallacy firsthand. And while wasting time on bad entertainment is one thing, applying this same flawed thinking to your finances can have a much bigger impact.
What is the Sunk Cost Fallacy?
At its core, the sunk cost fallacy is our tendency to continue investing resources (time, money, effort) into something simply because of the resources we've already spent, rather than making a rational decision based on the future costs and benefits. The money or time is gone, or "sunk," regardless of what you do next, but our brains trick us into thinking we need to justify that initial investment.
Real-World Examples
Let's look at how this plays out, starting with a non-financial example:
The Never-Ending Series: You're several seasons deep into a show you stopped enjoying ages ago. You keep watching because you've already invested so much time, even though continuing only costs you more valuable hours.
Now, how does this show up in our financial lives?
The Money Pit Car: You've poured thousands into fixing an old car that constantly breaks down. You authorize yet another expensive repair, influenced by all the money already spent, rather than objectively looking at the ongoing repair costs versus buying a more reliable vehicle.
Sticking with a Pricey Fund: You've held a mutual fund with high fees and mediocre performance for years. You're hesitant to switch to a better, lower-cost option because you've been in this one so long, even though the fees are hurting your future returns.
Why We Fall Into this Trap
It's not just about being stubborn. Our brains are wired with certain biases. One major player is loss aversion: the pain of losing something feels much stronger than the pleasure of gaining the equivalent amount. Selling a losing investment or abandoning a costly project feels like a clear loss, and we'll go to great lengths to avoid that feeling.
How to Identify and Avoid the Sunk Cost Trap
Focus on Future, Not Past: When making a decision, consciously ignore what you've already spent. Ask yourself: what are the future costs and benefits of continuing versus stopping? Your past investment is irrelevant to the future outcome.
Ask the "Would I Start This Today?" Question: If you hadn't already invested anything, would you put money, time, or effort into this today? If no, you're likely influenced by sunk costs.
Set Exit Strategies: Before you even start a project or make an investment, decide beforehand at what point you will cut your losses if things aren't working.
Seek an Outside Perspective: Talk to a trusted friend, family member, or financial advisor who isn't emotionally invested in your situation. They can offer an objective viewpoint.
Reframe "Loss" as "Lesson": See sunk costs as learning experiences that inform better future decisions.
Recognizing the sunk cost fallacy is key to making more rational and effective financial decisions. By focusing on the future and detaching from past investments, you free yourself to pursue opportunities that truly serve your financial well-being. Letting go isn't failing; sometimes, it's the smartest financial move you can make.
Let's Talk Money!
Think about your own personal finances. In what areas might you be influenced by the sunk cost fallacy?
Choose one of those areas. What is one concrete step you can take this week to evaluate the situation based on future costs and benefits, and potentially move forward?
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Disclaimer: This blog provides general financial information only, not professional financial advice. You are solely responsible for any decisions you make based on this info. Conduct your own research and consult with a qualified professional before making any financial decisions.