Common fallacy: sunk costs matter

The other day while chatting with The Dominoes, Seth imparted a life changing lesson to us and I wanted to share it with you. It's one of those "aha" moments that change the game. The message was simple but profound. People think that sunk costs, in terms of economics,  matter. They think that something they did yesterday  somehow should influence the decision they make today.

But they don't.

Let's start with what sunk costs are so that we are all on the same page.  According to Wikipedia, sunk costs are:

retrospective (past) costs that have already been incurred and cannot be recovered.

They're past costs, events and investments.

At first glance you would probably say something like, "Of course they matter! How can they not? In other contexts, like friendships, maybe they do. But in terms of business and economics, they really don't.

We tell ourselves things like, "well our life has led up to this opportunity...we have worked so hard to get "here". We can't change that now."  The implication is that the previous hard work somehow obligates you to continue on your current path, even when that path no longer makes sense or when better, more sensible opportunities present themselves.

But that just isn't true.

Think about the person who has been in med school for 2.5 years and realizes as they cut open the cadavre to see the internal organs for the first time that they no longer want to be a doctor. In fact, they can never see themselves performing surgery or working with the ill at all. So they quit.

Common sense would say that they should stick with it though, right? I mean what about the thousands of dollars invested? What about the time investment? And what are they to do now?

It doesn't matter.

She's realized that isn't what she wants. It's easier to say that sunk costs matter because it allows past events to dicate future action. It allows us to not think. It eliminates 'risk' and creates a sense of comfort. We don't have to determine which of the current opportunities are the best because we can just sit back and let what happened yesterday dictate today.

Why do companies still use television commercials or super bowl ads?

Why has the publishing and music industry refused to change, even if only to save themselves?

Why do students who decide that grad school isn't for them continue with it?

They think sunk costs matter.  So they stay stuck: in their business, in their marriage and in their jobs. Unwilling to pursue the new opportunities that present themselves, they make a grave error.

At the end of the day, the story you tell yourself of "what is took to get here" is irrelevant to the current decision you need or should make. Past events and investments will not indicate the next smartest decision based on your current circumstances. If it's a good idea, it's a good idea. Yesterday's news isn't going to change that.