Don’t Confuse Value and Sunk Costs

by Evan

Yesterday, I was in the middle of “intense” negotiations regarding a fantasy football trade and I was quickly reminded about a Warren Buffett quote that is often repeated.  It was from the Berkshire Hathaway 2008 Annual Letter,

Long ago, Ben Graham taught me that “Price is what you pay; value is what you get.” Whether we’re talking about socks or stocks.”

In this particular situation we were talking about a player that was drafted in the first round who hasn’t panned out but the other player wanted me to pay because of that fact.  Yes, my rejection email included the quote.

Sunk Costs are a Fact of Life

It seems that the sunk cost fallacy is almost innate in most humans.  As discussed on the Wikipedia entry,

Behavioral economics recognizes that sunk costs often affect economic decisions due to loss aversion: the price paid becomes a benchmark for the value, whereas the price paid should be irrelevant. This is considered irrational behavior (as rationality is defined by classical economics). Economic experiments have shown that the sunk cost fallacy and loss aversion are common; hence economic rationality—as assumed by much of economics—is limited. This has enormous implications for finance, economics, and securities markets in particular.

or simply put by freakanomics

Sunk cost is about the past – it’s the time or money or sweat equity you’ve put into a job or relationship or a project, and which makes quitting hard

Lifehacker had a few easy examples to understand

  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.”

Maybe it goes back to our distant ancestors needing to follow through with tasks that seemed hopeless…mother nature almost telling us that we need optimism to survive?  maybe it is a cultural personal responsibility issue?

I am not particularly good at recognizing that I am in a sunk cost fallacy when it comes to an investment of either time or money.  I am pretty sure it has to do with the optimism I feel once I have actually decided to undertake a project (versus my natural pessimism prior to actually accepting the responsibility).

I doubt I am alone, but I would love to hear of other’s examples. 

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5 comments

Lazy Man and Money October 10, 2014 - 8:35 am

That Lifehacker quote hurt deep. I’ve seen all the Twilight movies. I considered it a badge of honor to have endured it.

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Money Beagle October 10, 2014 - 9:40 am

I’ve started to apply this to the books I read. I get a lot of books from the library, often just based on the description provided on the jacket cover (I have an RSS feed as new books come in). With that, some books just don’t live up to what I’d hoped. In the past, I’d often trudge through figuring that I started, I might as well finish, but now if I get to about 25% through and I’m not feeling it, I put it down and move on to the next one. And, you know it was a good choice when I don’t even flip to the last few pages to see how things turned out!

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Myles October 11, 2014 - 7:11 am

Any sentence which begins “I might as well…” means it’s probably a bad idea: if that’s the best excuse you can come up with for doing something, shouldn’t you be doing something else? You might as well.

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Toni October 13, 2014 - 12:58 pm

That’s a hard lesson to learn. Hopefully I’ve got a better handle on when to cut losses and move on going forward!

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Funny about Money October 13, 2014 - 9:52 pm

Ahhh! GOT it!

And here’s the Big Grand-daddy of sunk cost examples: “I’ve gone this far through the English Ph.D. program…I can’t quit now!”

Gaaaaaaaahhhhhhhhhhh!

One of my grad-school colleagues was smart enough to cut his losses at the Master’s level…ended up as a vice-president of Paramount Pictures. {sigh}

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