Sometimes it’s hard to let go
This post will walk through the economic concept of sunk cost and how it should impact your decision making process. Not everyone has heard of this financial term but everyone has likely dealt with the topic.
A Formal Definiton
Sunk cost is a cost that has already been incurred and cannot be reimbursed or recovered in part or in full. The money is spent and gone forever.
Examples: Your time, commission fees on investments, insurance deductibles, and that boat you bought.
A Second Term: Confirmation Bias
Confirmation bias refers to human tendency to search for and read into or interpret information that matches with our existing conclusions or ways of thinking.
Examples: searching for “is X a good investment”…. you will surely find a site that says yes!
How These Two Concepts Interact
We have all been there – you have bought something and later have to make a big financial decision on that item but feel the item is worth more or only needs x,y,z investment and then it will be worth X, you’ve even got the internet research to prove it.
The initial cost or investment is sunk cost and the money is gone and your self fulfilling research is your confirmation bias showing up. Both of these shouldn’t even be impacting your decision making but they likely are.
How To Logically Think Through a Financial Decision
Ultimately any financial decision should be based on the net impact of future financial cash flow and return…. not how much cash you already have tied up in something.
Cars, boats, investments, and all sorts of hobby items typically fall the most often into this category.
Pull out the calculator and divorce yourself from the emotion of something that has cost you a lot of money and assess the cash flow moving forward.
If it’s not working – it’s not working – move on.
- Spent a bunch of time and energy on your blog or side hustle and it’s just not yielding any profit? Abandon it.
- Have a paid off car that has maintenance cost of $300 a month on average but a new car you have been eyeing will only cost $200 a month? Sell the car reduce your cash flow need even if it means some debt. You are cash flow positive.
- Bought that XYZ stock at its peak and it just isn’t moving and the shine has worn off and have the ability make a guaranteed return of 5%+ on paying off your debt? Sell the stock, pay off the debt.
- Did a bunch of custom work on your car, boat, house, or something else and not able to sell it for what you thought it should be worth? Sell it and move on.
But I Put in X amount of time or money
Your brain is going to scream as no one wants to quit an investment, a hobby, or a passion project but sometimes you just need to walk away.
I’m all for pushing through the wall (I’ve done it with this blog) – but we all know someone who put in a lot of time and or a lot of money into something and not letting go when they should – make sure you aren’t that person.
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