A sunk cost is a cost that has already been paid that is irrelevant to future decisions.
Here is a personal scenario- I was deciding what I should do for health coverage given that I am self-employed. Do I sign up under my wife’s work or find an additional option? I chose an outside option that had a non-refundable $200 application fee. Thereafter, I learned my wife’s work was going to be offering a new lower cost health plan at the next open enrollment. Should the recently paid $200 application fee be included in the analysis of which is a better option (continuing my coverage or the new plan at my wife’s work)? No. Under both scenarios, the application fee is paid and gone and is therefore a sunk cost.
Understandably, we don’t want to make poor decisions but in our pursuit of not making poor decisions we sometimes follow sunk costs with additional cost. Given that we are not all-knowing, we must make the best decisions we can with the information available to us without allowing prior non-refundable expenses to “guilt” us into doing one thing or another.
Interesting Article(s) or Video(s) Behavioral Economics - Sunk Cost Fallacy
This page provides a quick definition with some relatable examples of the sunk cost fallacy.
Calibrating Capital - Safeguarding Against Confirmation Bias in the Information Age
This article by Jeremy Walter (a friend and fellow financial advisor) is simply excellent and brings to light another behavioral tendency humans have that can affect our financial decision making.
Thank you for reading! Have you been tempted to allow sunk costs to influence your decision making in the past?