What Is a Sunk Cost?

A sunk cost expense refers to the loss of time, money, or effort, which you can't get back. If you let sunk costs influence your future decisions, even when it's 澳洲幸运5官方开奖结果体彩网:not in your best interest, you may run into problems.

For example, you've paid for a non-refundable, expensive eight-week online course at a prestigious university. In week two, you realize you do not enjoy the course, and it won't benefit your end goals. Do you continue with the course even though you've paid for it? It would require more time and effort on your part if you do.

How Sunk Costs Work

Sunk costs apply to personal and business settings. Once the resources (time, money, effort) are spent, they're gone and can't be recovered, no matter the outcome. Rational decision-making assumes that sunk costs should not affect future decisions.

For example, Company ABC invests millions of dollars in developing a new product. Halfway through the development phase, new 澳洲幸运5官方开奖结果体彩网:market research🅺 shows a shift in trends—notably, that the product won'🦋t sell when completed.

Should the company push forward with development or cut its losses? A rational manager would ignore the sunk cost (the amount of capital already invested in developing the product) and only consider the prospects (the final product won't sell). However, many companies would continue to justify the spent costs and continue, which often results in more losses.

The Sunk Cost Fallacy

The sunk cost fallacy is the mindset of continuing with a decision just because of past investments, even when logic would say otherwise. It is a flawed process of think🧸ing. This happens because of the human aversion to waste and the need to justify our decisions.

The sunk cost fallacy occurs often in business and government settings. Governments frequently continue funding large 澳洲幸运5官方开奖结果体彩网:infrastructure projects𒉰 that exceed budgets, spending billions and justifying them because ✱of the amount of capital already allocated to these projects.

For example, the U.K. and France continued to fund the Concorde even when it was not profitable. After the project's launch, it was quickly clear that there wouldn't be much of an economic gain.

Bad 澳洲幸运5官方开奖结果体彩网:marketing choices, extremely high production, maintenance, management, and fuel costs, and low demand due to high prices showed that there would be no financial benefit. Yet both countries continued to invest heavily in the project.

Behavioral Econꩲomics: Why the Sunk Cost Fallacy Exi𒅌sts

The sunk cost fallacy has its foundations in psychology and 澳洲幸运5官方开奖结果体彩网:behavioral economics with certa🍒in concepts that seek to explain why it exists.

• 澳洲幸运5官方开奖结果体彩网:Loss aversion: Humans tend to feel the pain of loss more than the happiness of gains, which explains why it's hard for people to walk away from sunk costs. Individuals may feel like they're incurring a loss if they discontinue, even though they've already incurred the loss. There may also be a false belief that the situation will turn around. This failure to acknowledge a loss can cause people and businesses to dig their heels in deeper, pouring more resources into failing enterprises.
• Commitment bias: Humans are creatures of habit and tend to stick with original plans. Once a decision is made, it becomes psychologically difficult to break from that decision, whether it's a lack of other options or failure to admit we were wrong. Known as cognitive dissonance, we justify our actions even when we know they no longer serve us.
• Endowment effect: People place a higher value on objects they own. Once we've invested in something, the value is greater to us than perhaps its actual value. This also means that if we walk away and incur a loss, that loss will be greater to us than the actual loss value.

Avoiding Sunk Costs

Avoiding the sunk-cost fallacy requires awareness and effort. Here are some ways you can sidestep sunk costs:

• Focus on future returns: Make decisions based on future returns rather than past investments. One could simply ask themselves: "Would I invest in this had I not already spent the resources?"
• Set limits/goals: Before committing capital or other resources, set a 澳洲幸运5官方开奖结果体彩网:stop limit. For example, if you invest in a stock, set a limit at which you would sell if the price drops. As a business owner, you can set periodic milestone reviews before committing further capital. If your goals are not met, it is time to reevaluate.
• Seek external counsel: We become emotionally tethered when we invest our resources. To help get a clear perspective, consult someone who does not have skin in the game. An unclouded view can help with decision-making.
  

The Bottom Line

Sunk costs are expenses, whether time, money, or effort that can't be recovered, yet they often influence future decisions—much to the detriment of the individual or business.

The 澳洲幸运5官方开奖结果体彩网:sunk cost fallacy makes continuing with a failed decision seem like the right course, however, a conscious effort needs to be made to recognize the bias and make better decisions. Setting clear limits, seeking an outside perspectiveꦗ, and considering ꦯfuture returns can help avoid sinking more resources into a failed enterprise.