Have you ever gone to a movie, realized part way through you’re not enjoying it, but felt compelled to stay to the end?
You paid for your ticket – how can you not finish the film?!
If this sounds familiar, you’ve experienced The Sunk Cost Fallacy.
What is the Sunk Cost Fallacy?
According to Behavioraleconomics.com, “Individuals commit the sunk cost fallacy when they continue a behavior or endeavor as a result of previously invested resources (time, money or effort)1. This fallacy, which is related to loss aversion and status quo bias can also be viewed as bias resulting from an ongoing commitment”2
In layman’s terms, you keep doing something even if you probably shouldn’t, because you’ve already put money, time or effort into it.
In our movie example, we’ve already paid for the ticket, which is the ‘sunk cost’. Even though we aren’t enjoying the film, we feel the need to finish it, investing additional resources.
In this example, the additional resource is time and maybe our sanity depending on the movie – like any Adam Sandler’s comedy of the last 15 years?!
Often the ‘Sunk Cost Fallacy’ can also cost us more money!
One of the first times I became aware of the Sunk Cost Fallacy, I saw it in action without knowing exactly what it was and certainly didn’t know the term.
I was a young teenager at one of my first jobs in retail.
The store owner never, ever wanted to sell anything below cost.
If product came didn’t sell, over time he would mark it down, maybe even to cost, but never below cost.
Typically all retailers prefer not to sell things below cost – I get that, it’s not rocket science why.
But if it just doesn’t sell, that’s where the ‘Sunk Cost Fallacy’ comes in.
The cost has already been incurred. You (sadly) can’t hop in a DeLorean to go back in time and change it.
In this case, the real problem was that there was a ton of inventory accumulating that just wasn’t selling, none of which was being repriced to a saleable price as it would put it below cost.
Probably without even realizing it, the store owner was experiencing the ‘Sunk Cost Dilemma’.
That’s the dilemma we are faced with when we need to make a decision about something for which we’ve already invested resources.
What should he have done?
To successfully navigate any Sunk Cost Fallacy or Sunk Cost Dilemma, we need to approach it as if there were no Sunk Cost, making our decision kind of pretending that the cost never happened.
If a product cost $2, but could only sell at $1.00, that is what it should be priced at, regardless of the fact that it’s well below cost.
Yes, it’s a loss, and nobody likes to lose money.
But, isn’t it better to get $1 instead of $0? Let’s say there was $10K in inventory with the same problem. Instead of it sitting there, not selling, collecting dust, he could have sold it off for maybe $5K.
That’s $5K more than he would got by refusing to price below cost.
He would now have $5K to invest in better selling product (hopefully seeing better returns).
That store is no longer in business.
Of course, there’s always a risk that you make a move too early. Maybe if waiting a bit longer, that $2 cost item could have sold at more than the $1 I suggested.
Maybe, but there’s always some risk, you could also move too late. It’s certainly something you need to consider in your Sunk Cost Dilemma.
Does the Sunk Cost Fallacy really influence us that much?
This article references a study where “people were asked to imagine that they were accidentally scheduled to take two trips — one to Montreal, and one to Cancun — during the same weekend, forcing them to choose one. When they were told one flight cost $200 and the other cost $800, people were significantly more likely to opt for the pricey trip — even if they would have preferred the cheaper destination. This effect held true whether people imagined that they had booked the flights, or that friends had given them the tickets as gifts.”3
The person conducting the study explained how they would approach a Sunk Cost Fallacy: “What’s done is done. There’s nothing you can do to regain money that’s lost — and pursuing something that makes you unhappy not only isn’t going to get your money back, but it’s also going to make you worse off. You’re just digging a deeper hole.”3
This can happen in any aspect of life, including relationships. If we are in a toxic friendship or bad romantic relationship, the longer we’ve been in it, the more compelled we feel to stick with it regardless of how bad it is for us.
Here are some Sunk Cost Fallacies we may encounter that can hurt our pocketbooks.
- Clutter or other stuff we no longer use (clothes shoes, handbags, toys, etc) – I can’t get rid of that thing – I paid $100 for it! If we just aren’t using it though, we could net us some decent cash via eBay, Kijijij, Craigslist, a consignment store or garage sale. Even just donating it can help save resources like our peace of mind through reduction of clutter.
- Investments – Refusing to sell until it ‘bounces back’ and sometimes even buying more at the lower value! Be careful with this one, as investments go up and down all the time, but if it’s dropped with zero indication it will go back up, cut your losses and move on.
- Non-refundable Travel Reservations – I work for myself, and sometimes book things not knowing when a new work project may come up. If a well paying gig comes up at the same time as the trip, don’t just automatically go on the trip because you’ve incurred a non-refundable cost. Weigh the loss out against the potential income from the project.
- Service or Financial contract – cell phone, mortgage, bank or credit fees – if you sign up for something thinking it’s one price, then keep getting dinged with fees you’re not expecting, maybe it’s time to pull the plug, even though you’ve already paid in.
- House – While some may say every house is a money pit, if yours really is one, maybe it’s time to cut your losses and sell.
- Home Appliances – If the repairs are costing more than a new one, get a new one.
That last one may have you scratching your head if you read my post a few months back ‘Repair Don’t Replace and DIM’. Typically, I do prefer to repair instead of buy something, I just don’t keep putting money into something just because I’ve already spent money on it.
Also be careful of Sunk Cost’s that could be part of company’s sales tactics. Companies often leverage the Sunk Cost Fallacy by requiring us to make an upfront investment, which kind of locks us into future purchases.
That golf club or retail (Costco and Sam’s Club) membership are perfect examples. If it’s been awhile since your last visit, you may feel compelled to go, as you need to make use of that paid membership. Several hundred dollars later…
How can we ensure we make the right decision when faced with a Sunk Cost Fallacy or Sunk Cost Dilemma?
The approach is simple really. Understand what the costs and other resources invested were and recognize they may be influencing your decision. Do your best to put those invested resources out of your mind when you are making the decision to go forward or not.
I understand that’s easier said than done, but I guarantee just understanding and recognizing when you’re experiencing a Sunk Cost Fallacy, will go a long way helping us in Doing More with Our Money.
Thanks for reading!
PS Thanks to Elizabeth for suggesting this topic!
1 Arkes, H.R. and Blumer, C. (1985) The Psychology of Sunk Cost. Organizational Behavior and Human Decision Processes. 35, 124-140.