Being the nerdy financial blogger that I am, I recently was having a discussion with a friend on the idea of sunk costs. We came to the conclusion that sunk costs play a huge role in our lives and yet are not at all understood. I’d like to change that, prepare to have your mind blown. Once you understand sunk costs, you’ll never go back.

The idea of a sunk cost is that past events should not direct our future decision making. The variables that help us make a decision should be independent of something that occurred in the past. We see this play out in a lot of areas of our lives, both big and small. Let’s talk through a couple of examples.

This past fall, my beloved UNC Tarheels came into town to take on the Yellow Jackets of Georgia Tech. A couple of friends and I decided to go. We each bought a ticket for $50. The day of the game came and it was pouring rain, and it was cold. Cold, wet and miserable. We had a decision to make–whether to go to the game or not. We’d spent $50 on tickets, which isn’t a small sum. We sort of didn’t want to throw that money away. However, more than not wanting to waste money, we really didn’t want to stand in the cold rain. Using the idea of sunk costs, we realized that we’d already spent the money on the tickets and that the cost shouldn’t affect our decision. Our decision at the time was not about whether to get our money’s worth, but whether we wanted to stand out in the rain or not. We decided to skip the game and to stay in, and happily watch the game from our living room.

A sunk cost is the idea that you can’t get something back. We’d already spent that $50 on the tickets and weren’t getting it back. We then factored it out of our decision making process. The two common things that come up with sunk costs are time, and money. You’ll hear people say things like ‘well I’ve already spent so much time on it…’ or ‘well I want to get my money’s worth’. Nope. Get that attitude out of there. Stop making decisions based on something that you can’t get back.

The other classic example is an all you can eat buffet. You pay your fee to get in, and then can eat to your heart’s desire. The problem is that most of us really want to get our ‘money’s worth’, and we end up overrating. Using sunk cost, we should realize that the fee we paid to get in isn’t recoverable, and shouldn’t factor in to our decision of how much to eat. We should eat until we are full and not a plate more.

The economic term for this is: maximizing your utility. When making a decision, be forward looking, not stuck in the past. Learn to realize that money and time spent isn’t returnable, and therefore shouldn’t play a role in your decision. Learn to live in the present and it will set you free!

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