From time to time we do a bit of work with Simon Lempriere from the Money Mentalist, as they work in a similar field to us. Simon’s written this blog, in which he shares his top tips on sunk costs and knowing when to pull the pin and stop throwing good money away!

Throwing good money after bad or the ‘Sunk Cost Fallacy’ is another form of overspending that we can slip into without realising.  It could be the house renovation that becomes the never ending money pit and deep down we know we will never recover these costs when the house is sold.

Sunk Costs are everywhere and they don’t occur only in your finances or business.  Have you sat through a really bad movie thinking “oh well, I’ve watched an hour so I may as well watch the rest.”  Gottcha!!  You have just succumbed to a Sunk Cost.

So, what is the Sunk Cost Fallacy?  Well, in a nutshell: we keep making decisions (monetary or otherwise) based on how much we have already spent on a project.  It’s hard to let go of something that is going backwards, or not complete an expensive project even though the cost of continuing just isn’t logical.

“You have to put a stop to this, this business just isn’t going to work, you are just throwing good money after bad and it is jeopardising your other businesses.”  This was a conversation I was having with one of my clients.

From my view, it was clear that the business was losing a lot of money and throwing more money at it wasn’t going to help it.  The rational decision was to stop, sell what we could to recover some of the investment and move on to the next project.

But from the owner’s perspective, he had sunk a significant amount of money and time into this venture and he wasn’t prepared to cut his losses and walk away just yet.  Emotions had clearly overridden his business sense and admitting that he had made the wrong decision and lost money, just wasn’t an option.

We get caught up in the Sunk Cost Fallacy because we emotionally invest in the resources, money or time that we have committed in the past and that impacts on how we assess what we are going to do in the future.

Using the house renovation example, here are some tips to help you recognise and avoid Sunk Costs.

  1. Before you start, write a pro’s and con’s list. If the only pro on the list is you feeling better emotionally about the project, then stop!
  2. Do some serious planning. Have you had the plans signed off by council? Do you understand how much time, energy and money you prepared to commit to the renovation? Has your mortgage broker organised funding and does it include contingencies? Have a Go/Kill plan.
  3. Set some targets and accountabilities. Has your draughtsman/architect talked to the builder? Is the builder clear on what you want to achieve? What is the payment schedule for the builder? In other words, monitor the project to make sure it is on track and on budget.  If it isn’t, pause, re-evaluate and make a decision at that point about how to proceed.
  4. Have someone else looking over your shoulder.  It is easier for another person to identify Sunk Costs than it is for you to see through the cloud of emotion, i.e. you can’t see the trees for the forest!
  5. Be prepared to pull the plug. Identify your contingencies limit. You have spent the time, money and resources and now they are gone.  Are you prepared to walk away, get over it and move on?

Walking away is a hard decision, but often it is better to sell and cut your losses than it is to keep pouring in money to a project that is sinking you. Just ask an owner of leaky building.

If you want to know more about Sunk Costs, or need help with your money, drop us an email  or pick up the phone and give us a call.


 SIMON LEMPRIERE
Simon Lempriere

Simon, co-founder of Money Mentalist, has a background that includes positions as a senior engineer, a marketer and director with multi-national technology corporations and is a widely regarded expert in the arena of raising capital for R&D and Business Development. This gives him a valuable insight for clients merging emotive, financial and commercial goals.

The combination of his own experience in corporate life, as a successful consultant plus his expert network means he provides a very powerful advisory and implementation service for his clients on their growth ambitions. Find out more here.

Money Mentalist

About Campbell Hastie

Cam is one half of Auckland based mortgage brokers, The Go 2 Guys.

He makes a living by sharing what he knows about mortgages with people, arranging mortgages for people and then insuring people.

He doesn't claim to know everything about mortgages himself which is why he teamed up with David Mercer — hence the ‘2’ in Go 2 Guys.

He writes posts regularly on his blog and has been told he has an ability to share his knowledge in a simple and sometimes memorable way.

Feel free to comment and ask any questions. Contact Campbell Hastie m: 027 697 7789.

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