Make Smarter Decisions by Ignoring Sunk Costs

I spent a short time working in IT early in my career. At that time, I recall a conversation with a man I'll call Josh (I'm calling him that because that's his name and this makes him look intelligent, because he is). I don't recall exactly what the conversation was about, but I remember one sentence in particular:

Don't make a decision based on sunk cost.

It made sense to me at the time, and I've repeated it to several others since then.

But what I didn't know at the time was that sunk cost is an economics term (I guess I skipped class that day). Quoting the all-powerful Wikipedia:

In economics and business decision-making, a sunk cost is a cost that has already been incurred and cannot be recovered.

And there's another term that represents the combination of sunk costs and decision-making. It's called the sunk cost fallacy. Again, from Wikipedia:

Many people have strong misgivings about "wasting" resources (loss aversion). In the above example involving a non-refundable movie ticket, many people, for example, would feel obliged to go to the movie despite not really wanting to, because doing otherwise would be wasting the ticket price; they feel they've passed the point of no return. This is sometimes referred to as the sunk cost fallacy. Economists would label this behavior "irrational": it is inefficient because it misallocates resources by depending on information that is irrelevant to the decision being made.

Fancy language aside, it's saying that to make a decision based on a cost you've already incurred is illogical, simply because it should have no effect on the future (it's gone).

Using the example above, to choose to see one movie over another because you liked the preview better is logical. To choose a movie because it's shorter also makes sense. Or even to not see a movie in 3D because it's less expensive -- that, too, is logical.

But, to go to a movie simply because you already bought a ticket makes no logical sense.

We do this all the time. I came across an article by Michael Davidson that provides a few good and common examples. That article said a lot of what I wanted to say here. The only thing I don't love is that it tells you how you're being stupid, not how to be smart. So, let's try that.

... with a side of guilt

Let's look at Davidson's four examples:

1. "I might as well keep eating because I already bought the food."
2. "I might as well keep watching this terrible movie because I've watched an hour of it already."
3. "I might as well keep going to a bad/useless class that I paid for."
4. "I might as well continue dating someone bad for me because I've already invested so much in them."

I believe that we make these decisions not be they're illogical (that would be illogical!), but because we (maybe subconsciously) find them to be emotionally logical. We'd feel bad if we didn't do something. Or we'd believe we didn't get our money's worth.

It's our emotions, namely guilt, that drive these decisions, and emotions can be powerful motivators.

The problem these emotions is a) they don't feel good, and b) they're not always logical or smart.

So, the big question becomes:

How do we make smarter, more logical decisions?

The key is figuring out when you are making a decision based on sunk cost. But it's not as easy as it sounds. That's because we're often making decisions without actively thinking about them.

We need to change that.

To do so, get into the habit of asking, "Why?" when you are about to do something. Asking why is powerful tool for drilling down into the root of something. For example, Why am I going to the movies?

Asking why will lead you to the core motivator for your decision. You are on the lookout for time or money that is already gone.

For example, these answers are logical, even if they're a bit goofy:

• "Because I want to see the movie."
• "Because the popcorn lady is really attractive."
• "Because I have nothing better to do today."
• "Because I like the smell of the wall carpet in the theater."
• "Because it's raining."

These answers are not logical:

• "Because I already bought a ticket."
• "Because I spent so much time reading about it."
• "Because I've already driven this far and I'm in the parking lot."

Now, even if a decision is not logical, that doesn't mean the logical decision is to do the opposite. You just need a different reason for doing that thing. So if you already bought a ticket to the movie, that's fine. But you should go because you want to go, or because you want to see the popcorn lady, or for any other logical reason.

But sometimes guilt sticks around

But wait! Sometimes the guilt of a decision, even if it's illogical, will stay around. That doesn't feel good, and that makes making some logical decisions undesirable.

In other words, you may be thinking, I may not want to see the movie, but I hate wasting money.

To that I have two items to address.

The first is bigger and more difficult. Look, guilt is difficult to get rid of. It can take a lot of effort and a lot of practice to learn to brush away guilt. And still that doesn't always work. I get that.

A tool you can use is to redirect your guilt. We do this a lot, right? It's called rationalizing. I'm not usually a proponent of rationalizations, but in this case, you can kind of trick your emotions, and that can be useful.

In this case (my second point), realize that you're not actually wasting money. Seriously. The money is already gone.

Look, the money earned you a ticket, right? The ticket gets you into the movies. The money doesn't get you into the movies and the money is already gone. So, if buying the ticket brought you some sort of joy, then the money you spent was already worth it.

So if you're worried about wasting a piece of paper, who cares? It's a piece of paper, it has no feelings.

Remove sunk costs from your decision-making, and you'll make smarter decisions. Then use the logic inherent in the decisions you make to rid yourself of the guilt of making an illogical decision.