Tips for ignoring sunk costs

In economics, sunk costs are costs that have already been incurred regardless of how they are used. For example, let's say that a toy maker decides that he has a really great idea for a toy train made out of wood. So this toy maker goes out and buys $100 worth of wood. The purchase is non-refundable. A month into his wood train making project, the toy maker finds out that kids are no longer interested in wood trains, they want metal cars instead. The toy maker wants to make these metal cars because they will be more popular but doesn't want to "waste" all the time and $100 that he spent on the wooden train project. Should the train maker continue making the wooden trains simply because he has already invested time into the project?

This is the problem that many business owners face. Not a problem of whether or not to make trains but a problem of whether or not to switch projects or strategies when one project or strategy has already been started or money has already been allocated. When it does not make sense to continue on a fruitless project, the costs that have been allocated to that project are referred to as "sunk costs." These costs are gone, you cannot get them back. The thing that is so difficult for business owners to do is to ignore the sunk costs and make the best decision possible for the welfare of the company, even if it means switching gears entirely.

Different people handle sunk costs differently. Some people are able to see that the past is gone and that all that matters is the present in relation to the future. Economic laws state that "every owner of assets must compare the value of whatever he owns with his expectations regarding the value of whatever his wealth will be worth tomorrow." Our business responsibility is with the present and today is the day that we make decisions regarding our success.

Have you ever heard the tem, "Cut your losses"? This term is popular with investors because it reminds them that it is ok to recognize that you have had a loss. But it is not ok to let your losses dictate how you respond today. Some investors find it helpful to re-define their losses as opportunities, or even successes that help to make the investor more educated and experienced having obtained knowledge of what not to do.

There is no logical basis for holding on to the memory of a sunk cost. Do not let your ego hold on to costs that are unrecoverable. Such actions are simply irrational. Doing so will only hinder you from making progress. Every investor will experience sunk costs at one time or another. Even the most successful money-makers have had losses. You can also apply principles of sunk costs to some of our greatest national heroes such as Abraham Lincoln. Lincoln is famous for the way that he dealt with, learned from, and became better because of his failures, mistakes, and sunk costs.

Some times the market will make you a winner and sometimes it will make you a looser. There will be times when an investment pays off and sometimes when you will be stuck with the obligation to pay out. Ignoring sunk costs is often easier said than done, especially among those who make a living out of managing money. But having an understanding of the inevitability of sunk costs and preparing yourself ahead of time to be able to react in the most productive manner possible is something that we can all do.