The pitfalls of sunk costs
We have a 10-minute test in our household. We start a movie or a new show, and, if after 10 minutes we aren’t enjoying it, we stop, and choose something else. This is sunk costs in action. We are prepared to lose 10 minutes of our time for a bad movie, but no more. Too often we have got 1 1/2hrs in and the movie hasn’t improved, but we watch the last 15 minutes just in case it does get better. That’s throwing good time after bad.
Once you have sunk your time into something, you can’t get it back, and often it’s the same with your money. The phrase ‘spend money to make money’ doesn’t always work out that way.
Picture this, you have this amazing idea, a project that you want to do. So, you drop some cash into the pot, and poof! It vanishes into paying expenses never to return. That is a financial sunk cost. Economists love tossing around this term to discuss investments that are basically one-way tickets to the land of “no refunds.” When this happens, we will look at how much money we have sunk, but we’re not so good at looking at our sunk time.
Now, this is where it gets tricky: it’s easy to get all tangled up in these sunk costs when deciding whether to keep a project rolling. The thought process goes like this, “But we’ve already dumped so much money into this, we can’t just bail now!” But here’s the secret sauce – when looking ahead, those sunk costs should be as irrelevant as last year’s fashion trends. What really matters are the costs that are ahead, these are the relevant costs, not the ones chilling out in the rearview mirror.
By the way, this is why the Nigerian scammers do so well, they ask you to drip feed money in the hopes of the big return, the trap being the sunk costs that you have already ‘’invested’ looming large while waiting for the big return. Do you stop or do you carry on until you lose everything? This is where the sunk cost fallacy rears its head. You’re knee-deep in a money pit, and instead of climbing out, you decide to dig deeper because, well, you’ve already dug yourself in so deep. This is the sunk cost fallacy in all its illogical glory.
I have seen the sunk cost fallacy in action in business. There’s also an element of ego and self-esteem in play here as well. We pour our lives into our business, admitting that is just isn’t working is a very hard decision to make. Particularly, if you have staff who rely on you for their livelihood and your home is probably on the line as well.
I’m in the middle of a sunk cost exercise right now with my Mum. We need to decide whether to stay or change the real estate agent who is selling her house. Mum is saying ‘but look at how much we have already spent on marketing’. That’s the sunk cost part. On the other hand, I’m looking at the results to date and exploring to see who could potentially do a better job for us. I’m analysing the data. What results have we had from the marketing? What has the feedback been to open homes? Has the agency responded to the market slowdown? What are they suggesting as a plan to move forward? I’ve got a different company to appraise the property to see what they say. Once we have all the data, we can make an informed decision whether to continue or make the change.
The process Mum and I are going through right now, is how you get out of the sunk cost money pit and back on track.
Stop looking in the rear vision mirror. Get real and analyse what you need to do to climb out of the pit. Swallow your pride if you need to and just take the action you need to and do it !
One more point, once you have made the decision, make sure you monitor the outcome, so you don’t end up in the same place again.