Sunk Costs

by Kelly · 7 comments

in Money & Spending

holeOne of the hardest concepts for me to wrap my head around now that I’m in business school is known as sunk costs: the idea that when money has been spent on research or supplies with the goal of doing a project, it should not be taken into account when deciding whether or not to do a project.

“What do you mean it doesn’t matter if I’ve already invested money into this project?” my untrained brain wants to shout out. “Why can’t I let that influence my decision?”

And it turns out that business school really isn’t that far removed from reality. I’ve been letting sunk costs influence my life for far too long. Take for example some various crafting projects that I’ve had lying around my house. A few months before my best friend gave birth to her first baby, I decided to learn silk ribbon embroidery and make the baby a blanket- two projects for the price of one. I started a bit, and then put it aside, promising myself I’d pick it up and finish it later. My best friend’s daughter turned nine last month- I never did get much further than when I had started nine years ago!

Why am I telling you this story? To illustrate the difficulty I had in getting rid of certain things (which I never use) just because I felt like I paid good money for them. I never finished that silk ribbon embroidery kit, nor the fairy doll craft for which I bought the organic felt, nor the quilting, nor, nor nor…

The fact that I had spent money on each object prevented me from being objective as to the likelihood of ever finishing the project. And that is a really important step, in my opinion! There are many times that we should just let go, and sacrifice the money already spent, if doing so will help us acheive our future goals. This particular example involved sacrificing the purchase cost for the goal of being more organized and less cluttered, but another goal might be stopping your gym membership, even though you’ve been paying on it for months.

Are you good at sacrificing sunk costs in order to meet your goals? Maybe you hate to take them out of the equation! Have you ever had a hard time getting rid of something just because you already paid for it?

{ 7 comments }

1 jpritchard March 4, 2009

i think that, finally, at age 25 i'm realizing that my tweenage spending habits need to go….by that i mean shopping the sales at Old Navy *just because* there was a sale or buying a shirt i *just might maybe possibly wear* but don't really LOVE because it is only $2 or restocking my supply of scrapbooking paper (even though it was already well stocked) because the craft store is having a sale…ALL of those are not okay anymore. buying things JUST TO BUY THEM or convincing myself that despite my closet of full of craft supplies I STILL NEED MORE are things i'd really like to leave behind.

the difficulty i have is drawing the line between being "frugal" & buying in advance when things ARE on sale (like that scrapbooking paper that is 50% off or that winter sweater i won't use for another 6 months) and STILL LIKING THEM + FEELING SATISFIED when i finally get around to using them…

any tips? 🙂

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2 Julie March 4, 2009

Yes, I agree. There's often an emotional or financial attachment to things don't we don't use and that clutter our lives.

Well, you could sell your craft supplies on Ebay and get some of that initial investment back.

<abbr>Julie´s last blog post..Wordful Wednesday</abbr>

3 Annabel March 4, 2009

I was totally ruled by the sunk cost fallacy until I read a book some years ago called “Why Smart People Make Big Money Mistakes and How to Correct Them: Lessons from the New Science of Behavioral Economics” by Gary Belsky & Thomas Gilovich. They have a whole chapter about loss aversion and the sunk cost fallacy.

There was a study done where people were given two scenarios, one in which they were given a pair of tickets of a Chicago Bulls game and another in which they paid a small fortune for the tickets and there was no chance of selling them to someone else. In both cases, the main reason for going was to see Michael Jordan, but then they found out he was injured and wasn’t going to play. Plus, a sudden snowstorm makes the trip to the game unpleasant and potentially dangerous.

Most people said that if they paid a small fortune for the tickets they would go to the game anyway, whereas if they got the tickets for free they would stay home. Rationally, for those who paid for the tickets, the money has already been spent whether they go or not, plus going to the game means incurring an extra cost: the chance of dying or getting seriously injured in the snow storm. But emotionally, not using those tickets feels like having wasted and thus lost money, which most people (including myself!) hate more than they love making money.

Here’s another example that I think fits into this “sunk cost fallacy:” My husband keeps all kinds of (what I think is) junk in case he needs a spare part one day to repair something. I say having an uncluttered apartment now is more valuable to me than spending the money in some hypothetical future on the parts in the unlikely event we ever do need them. For my husband though, the thought of having to possibly pay for something that he could have had “for free” really bugs him.

4 Craig March 4, 2009

That is a tough decision when to stop something. That's like when I played the trumpet growing up, I finally stopped even though I felt bad my parents bought the trumpet instead of renting it. Still fell like for a few years it wasn't a waste, but not have a trumpet lying in the storage at home.

5 Stacey March 5, 2009

I *always* feel regret when I get rid of something, but I am getting better at not dwelling on the loss. A few weeks ago I learned that you could send your old electronic equipment to gazelle.com and they will pay you for it, even if it's not in perfect condition – something that would prevent you from selling it on eBay or Craig's List. I know my dad spent hundreds of dollars on a new dvd camcorder for me when my son was born but I took maybe one little movie of him and that was it – and he'll be 4 in May. I'm just not the camcording type and neither is my husband. But we take pictures and I've written in a journal for my son since he was born and he will have lots of "recorded memories" to look back on. So even though it is always momentarily hard to let something go, like the camcorder, I am starting to enjoy looking for stuff to get rid of if I do not love it or it is not useful. Today I got the check in the mail from Gazelle for the camcorder – $55 – and I am very pleased.

<abbr>Stacey´s last blog post..Banana Birthday Cake (Or What to Do When Bananas Are on Sale)</abbr>

6 Abigail March 5, 2009

I came across this concept about two and a half years ago, in some accounting classes. It's definitely a hard one to get around. We tend to invest value in things because we spent on them.

It's still painful for me to pare down my closet. I paid for this stuff. Surely, I'll wear it eventually! Well, have I yet? No. How long has it been? Two years… But I swear I'll wear it more this year!

It's hard stuff to deal with. We feel wasteful for throwing things away, so we keep them, hoping we'll magically get industrious and take an interest in something that's been neglected for a year or more. Not the most logical of assumptions, all in all.

I'm a pack rat overall, though. So I'm used to this. In the end, I just ask myself to seriously — SERIOUSLY — assess the likelihood that the item will see any real use. Usually, that's the only question that needs answering.

<abbr>Abigail´s last blog post..Carnival round-up</abbr>

7 Kristy @ Master Your Card March 9, 2009

I’m absolutely terrible about this. I really am a pack rat as a result. I know, logically speaking, that keeping this stuff around is not helping me achieve my goals. I know that it costs me more every time I move. But I still can’t get rid of it. I think some of it is emotional, too. They say 90% of finance is emotion (or is it 80%?), so if that’s true, that’s probably me. But, once you’ve sunk money into something, particularly an expensive something, it is very difficult to let it go!

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