Sunk Costs: Not Just a Finance Concept

During my finance degree, one of the topics that left a profound impact on me was the notion of sunk costs.

This impact deepened further when my lecturer extended the concept into the realm of sunk time. In finance, particularly in decision-making regarding resource allocation, sunk costs refer to expenses already incurred and unrecoverable after a decision is made. Similarly, sunk time represents the invested time that cannot be regained post-decision.

The significance became apparent when considering the budgeting of projects moving forward. Despite the capital invested early on or midway through a project, these sunk costs and time are not factored into the future considerations. It requires a departure from emotional attachment to assess whether the project aligns with return requirements moving forward, effectively disregarding past investments. This rational approach contrasts with our inherent aversion to losses, often observed in individuals persisting with failing projects simply because of prior investments. This behaviour mirrors the gambler chasing losses, perpetuating the cycle.

The application of these principles extends beyond finance and into personal decision-making. For instance, imagine a student three years into a law degree who decides to pursue a career in medicine. Conventional advice might urge them to complete the fourth year of their law degree since they’ve already invested significant time and effort. However, adopting the mindset of a finance professional would entail recognising the first three years as sunk time and promptly transitioning to studying medicine. Just as continuing to invest in a failing project yields diminishing returns, persisting in a path that no longer aligns with one’s goals due to past investments can hinder progress and opportunities for future success.

Once you become aware of these concepts, you’ll notice their presence in various aspects of human endeavours. For example, individuals may remain in relationships longer than they should simply because they’ve invested considerable time into them. Similarly, people might persist in careers that no longer fulfil them due to the extensive time and money invested in developing their skill set. Additionally, there’s the tendency for individuals to increase their stake in risky assets simply because they’ve already committed significant resources to them. These behaviours exemplify the sunk cost fallacy, where past investments influence present decision-making despite their irrelevance to future outcomes.

What made this concept particularly profound for me was realising how it had manifested in my own career decisions. Despite feeling unfulfilled and lacking mental stimulation, I found myself clinging to a path I had invested significantly in – seven years of studying sports and exercise science, along with a year-long unpaid internship, totalling around $50,000 in expenses. For three years, I worked in the mines managing gyms, overlooking potentially lucrative opportunities that came my way. Embracing the sunk cost concept enabled me to shift my focus away from past investments and toward what would truly benefit me in the future. However, the challenge lies in discerning between strategies to avoid the sunk cost fallacy and knowing when it’s appropriate to pivot. Jordan Peterson’s insight, albeit paraphrased, resonated deeply with me:

If the decision moving forward seems more daunting than sticking with the status quo, it’s not quitting but rather making a calculated choice for personal growth and fulfilment.

In conclusion, understanding the concepts of sunk costs and sunk time, and learning how to apply them in decision-making processes, is crucial. It’s beneficial to assess what you’ve invested, what can be recouped, and what constitutes sunk costs moving forward. When evaluating the financial viability of a project, it is standard practice to disregard sunk costs and, optionally, include recoupable costs. The decision should then be based on what aligns best with your goals and aspirations for the future. By adopting this rational approach, you’ll likely find yourself progressing more swiftly in your endeavours, unburdened by past investments that no longer serve your interests.

Thanks for reading, Dave G Stewart.

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