Wednesday, October 8, 2014

When Sunk Costs Help

When Sunk Costs Help
I love my little sister. After our parents divorced, we became modern day latchkey kids. We spent every weekday afternoon after school hanging out and playing mancala and watching t.v. And, yeah, back then I sort of tortured her, too. But in a loving, big-brother kind of way. The funny thing is that we grew up into such different people, even though we were raised in the same household. My sister is completely health conscious, hiking all over the place and eating organic foods; but exercise and diet are a constant struggle with me. I'm obsessed with finances and investments, while my sister would rather be doing something, maybe anything, else.

Different as we are, we have distinct ideas on what we ought to spend most of our money on, too. The other day we were talking on the phone and she mentioned the gym she and her fiancé go to: how it had a pool and good exercise classes, so I asked how much it cost.

"Well, it might seem like a lot," she said, "but it's worth it."

"Oh, how much is it?"

"So...it's seventy dollars a month."

I had to choke back a gasp at this point, but I reminded myself that I'm a frugal weirdo. Most people probably wouldn't blush at spending that kind of money on something as beneficial as a gym membership. And, to be fair, it is for three people: my sister, her daughter, and her fiancé. So at $23 per person per month, it's comparable to what you'd see at some other gyms. Still, it's $840 per year, so it's not exactly chump change.

But I was most intrigued by what she said next: "But we go all the time: at least four times a week. Seventy dollars is a lot to us, so we want to get our money's worth."

Sunk cost! My wife and I are huge nerds and love the concept of the sunk cost fallacy, so we yell out, "Sunk cost!" whenever we see an example. (It gets us some weird looks from time to time.) The sunk cost fallacy occurs whenever we let past financial decisions or costs illogically impact our present ones. The sunk cost fallacy is what keeps you sitting in a terrible play with your wife, even when you'd both rather leave, because you dropped $150 on the tickets already and want to have a fancy date night. Our subconscious doesn't like the idea of wasting money. So we suffer through the performance, "to get our money's worth." Logically speaking though, we ought to just walk out of the play. We're not getting our $150 back either way, but we can get those two hours of our lives back if we just head to the bar across the street.

When the costs of our past financial decisions can't be recovered, they're considered "sunk": like when Rose drops that fancy necklace into the water in Titanic. (Why'd she do that, anyway? That necklace could have been sold at auction and fed the world's poor for a year. And why couldn't she just scoot over and let Leo share the floating door with her? Quit being selfish, Rose.)



And in the case of my sister's gym membership, since she signed up for a year contract, those funds are as sunk as that fancy necklace at the bottom of the Atlantic, thanks to that wasteful old broad. (Man, I have some issues to work out with that lady.)

We typically think of the sunk cost fallacy as something bad: something that creates sub-optimal, illogical behavior. But in the case of my sister's gym membership, it's increasing a healthy behavior. She's going to the gym more often, because she doesn't want that $70 to go to waste. I asked if she thought she'd go less often if the membership were only $20 a month, or if it were free.

"No, I think I'd go the same amount." Her fiancé agreed.

But that's the tricky part with the sunk cost fallacy: we typically don't realize its impact on our behavior. We want to believe we're purely rational beings, weighing our options like cool, calculating automatons. But as David McRainey notes so eloquently, the truth is that your "decisions are tainted by the emotional investments you accumulate, and the more you invest in something the harder it becomes to abandon it." The sunk cost fallacy helps my sister work out more because it costs so much. She's "invested" more money into the gym, so it's harder to abandon the healthy behavior. My eight dollar a month gym membership is definitely less expensive, but then there's the pesky fact that I rarely go. Because eight dollars is no big deal, I don't get the same benefit of sunk costs.

Which all goes to say, there is sometimes a hidden cost to frugality. Buying the best value option will save us a few dollars, but may cost us in other ways. When it comes to healthy behaviors, like eating more vegetables or exercising, we might do better for ourselves if we fought our frugal tendencies, and bought the more expensive option.


*Photo is from Rennett Stowe at Flickr Creative Commons.

37 comments:

  1. Oh, I can totally relate to this post. We had a gym membership years ago and quit going when I became pregnant with our second child. It literally killed me to see the money come out of our account each month when I wasn't going!

    Then, once I had the baby, we started going more...mainly because we paid for it already. Sunk costs!
    I do wish I exercised more. For us it's just a matter of time. I'm barely treading water as it is with the things I currently have in my life. I do get in a 30 minute walk several times per week, but I wish I could do more.

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    1. My 30 or 60 minute walk is pretty much all the exercise I get most days. But it's a time I really treasure, as my wife and I talk more during that hour than we do the rest of the day. And then kickball once a week helps. :)

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    2. Really Holly? It Literally killed you!?!?! ;)
      (Sorry, one of my pedant bug-bears. I am sure you can find an example of mis-use on my blog if you look hard enough though!)

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  2. I love the psychology behind sunk costs, and this is an interesting way of viewing it. I am sadly prone to falling for it, because I also hate wasting money. I like to get what I paid for, even if I'm not emotionally invested in it. I try to avoid it as much as possible by researching beforehand! I'm not sure if I've ever benefited from it before. I'll have to think about that!

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    1. I think we're all susceptible to these sort of things (sunk costs, confirmation bias, anchoring, etc...) It's just part of being human, with a brain that was designed for a different environment and time.

      Rather than trying to fight these biases, sometimes we can use them to our advantage. It's rare, but it's nice when things line up for us.

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  3. Very interesting concept! (And I'm so heartened to learn that I'm not the only person who thought Rose was a little bit selfish and stupid - seriously, there was plenty of room on that door! Or at least plenty of other debris he could have used to save himself if he hadn't felt obligated to sit there in the freezing water holding her hand!)

    Anyhow, CatMan is really good about not falling for the sunk cost fallacy. If he's not into it (whatever it is) he doesn't do it, no matter how much he spent on it - bad movies rented on Amazon streaming, I'm looking at you! Me, on the other hand, I always feel guilty if I don't really use something that I spent money on. It doesn't generally get me to do something I really don't want to do, but I do waste a lot of time and mental energy on the guilt.

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    1. Rose is totally selfish. I ruin those scenes in the movie whenever I watch it, as I'm yelling at the screen the whole time.

      That's great to have a partner who's not as susceptible. Sometimes all it takes is a friend or partner who can be more level headed in the moment.

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    2. I remember a myth busters episode where they recreated the size of the door and the weight of Rose and Jack to see if she really could have let him share and I'm pretty sure the evidence was that it wouldn't have floated with both of them on there. Didn't say anything about other peices of flotilla around though!

      True Fact: theFIREstarter is one of only 10 people west of Munich that has not seen the film Titanic :)

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  4. What an interesting concept. I find that I'm the same way as your sister with my gym membership. My co-worker and I were just discussing this the other day actually...

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    1. That's great, Kayla. There are other applications to this theory, I think: the super expensive organic produce at a farmer's market, or buying "too many" vegetables at the store (inducing the desire to eat them, so they won't go to wastes), etc.

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  5. So, super curious. If you pay a lump sum up front, is there a diminishing effect?

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    1. Great question. I really have no idea. But in my own experience, buying the $100 year membership at the gym up front DEFINITELY does not induce me to go that often. I think there are diminishing returns since the purchase was so long ago.

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    2. Agreed. I've had the same experience, but didn't know if I was alone. :)

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  6. And you called ME a nerd today ;). I'm absolutely guilty of adhering to the sunk cost fallacy on occasion. I, in fact, have been that person sitting in that theatre watching that play, even though the tickets were--wait for it--free.

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    1. Ha! Nerds unite. I think we've all ended up throwing good time after bad money with some of our purchases, if that makes sense.

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  7. If a sunk cost is what it takes to motivate you, it may be worth it. But if that is what it takes, odds are, you are not motivated enough and it will be a waste of money...

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    1. Yeah, I'm not sure that sunk costs are necessarily going to work as a "sole" motivator. But their impact is undeniable. They definitely alter our behavior at times.

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  8. In defense of your sister's view, at some point she'll be month-to-month on her membership (if she isn't already - we were from month 1 at our "expensive" gym, it was the cheap one that had a year or more contract) and she wants to have the habit of going to the gym firmly developed by the time she gets to that point so it's a no brainer to continue the membership each month since she knows she's using it. If she isn't in the habit it's more of a mental struggle... "do I want to keep it and try and force myself to go or just admit defeat an cancel?"

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    1. Truth! Habits, habits, habits. That's the only way to success. I feel like sunk costs, in this case, might get her over the hump, so to speak, to creating that healthy habit, but who knows. It's hard to parse out the impacts.

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  9. Since our health is one of the most valuable assets we have, I think spending extra on food and exercise is more of an investment than $$$ wasted. I spend a little bit more on healthier food because of this, I did get rid of the gym membership for a couple reasons besides cost. I was not going enough, I walk my dog and do body exercise which cost nothing, and I'm all about saving money. I actually lost like 15 pounds after I left the gym which is kind of ironic, I also invested the $54 gym membership I cancelled into Nike, so a little more irony for you.

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    1. I love that you lost more weight after cancelling the gym membership. Many roads lead to Rome, and all that.

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  10. Very interesting point. With the example of the gym membership for your sister...sunk fallacy may be a positive since it'll motivate you to use the gym which is a good thing. Though she did say that they would go often anyway. $70 for 3 people for a gym with a pool isn't too bad...I guess I'm from NYC and prices here can be higher! I get sucked into sunk fallacy though where I supposed spend time thinking of ways to use something I paid for but don't want or can't use...just to get some value out of it. I don't want to admit that it is in fact a sunk cost.

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    1. I figure we all do stuff like that. I have a ton of items in my house that I keep around...just in case. I don't like admit that I wasted money on them years ago, and donating them now would force me to realize that.

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  11. I always associated 'sunk cost' as negative, but I like your spin on it. Ours combined probably total the same, though we use it frequently (4-6 times a week). For us it's become a morning ritual, though that will obvi change in a few months. Mancala!! Must be done with those little shells otherwise it's not really mancala. :)

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    1. That's an incredible workout schedule, Anna. And yes, Mancala definitely has to be played with the little white shells. In our household, we didn't even have an actual set: we just played with little wooden bowls.

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  12. Excellent post! How did you find a gym membership for $8/month???

    I had several wasted gym memberships when I was younger (never, ever (ever) went) and thereafter vowed to avoid them at all costs.

    When we moved to our current home, my recently divorced girlfriend/neighbor got all motivated to get back in date-ready condition and invited me to go to classes at our county rec center (and, no, just because it's funded by taxpayer dollars does NOT mean it is cheaper than other gyms).

    The classes were $5 apiece and once I got into the habit of going at least twice a week, it made sense to finally bite the bullet and commit for a year at $32/month (just for me). But since I took on a big project in August, I've only made it once a week - which means I am paying $8 per class!

    So...motivated now to work it back down to less than $5 per class by the end of the year, which means at 3 classes per week through December!

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    1. Thanks, Emily! Our city government created, maybe, the best value gym in the state: Club SAR. It's a boxing gym with a bunch of classes, ranging from yoga to boxing to MMA. Plus there's a full court basketball court. The best bit: not one tv in the place. Just people coming to work out. And, yeah, just $99 a year.

      http://www.scottsdaleaz.gov/parks/SAR

      I kind of like how you're calculating the per class price. I think that's a much more accurate (and motivating) way to break down the cost.

      I'm probably paying about $10 per class at this rate...will have to work on getting that down.

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  13. I love this sunk cost concept too. I think I get this effect in my career - I've been working at the same company for 10 years, having developed some relatively specialised skills. Whenever I start thinking about changing careers, either to do something more 'exciting' or 'meaningful', I feel reluctant to change because of all the cost and effort I've 'sunk' into this role. But when I reflect on where I have the most earning potential, the best alternative is probably staying in my current role - and my earnings potential is a huge factor towards my financial independence goals! So I guess the sunk costs of my job keep me going towards what it most likely the most financially rewarding path...

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    1. Sorry for the late reply! Sunk costs in career path is a fascinating concept -- one you could probably write a whole book on. Reminds me of "Who Moved My Cheese" in a way.

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  14. Oh man, I haven't seen Titanic yet...great...movie ruined for me :) Totally kidding. Interesting subject and haven't thought about it too much,,, but something to think about.

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    1. Thanks for commenting and reading, Lance!

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  15. Motivation also changes with age. I've always been a member of an expensive gym but when I was in my late 20s, it was the cost of the membership that motivated me to go, ie if I didn't go regularly, it was a waste of money.

    Now that I'm older, the cost is less important as I'm motivated to go because I want to stay fit and healthy!

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    1. That's cool how your motivations have become more intrinsic as you've grown up, weenie. Did that happen naturally, or did you have to drive the change?

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  16. I tried this logic twice (paying a "significant amount" - $50/mth for going to the gym). It didn't work for me. Maybe I wasn't paying enough? (Really, I just hate exercising...)

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    1. I wondered that, too. There's a certain dollar amount that "doesn't matter" for all of us. For sunk costs to work, we have to feel the pain of the money lost. Only then do we fear wasting it.

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  17. I too am super interesting in the sunk cost concept and am intrigued that you've found a way to make it useful.

    I would be super cautious though. Don't most sunk cost start out as a way to try and force you to do something good? CSA's. Zoo memberships to spend more time learning with the kids. That fancy product off of the infomercial to get your house so clean? Every one bought with the intention of making your life better somehow but bought with hard-earned money to invoke the guilt. But that's what it is. Guilt. Guilt can be a motivator (and sometimes the last resort) but it really is a terrible one.

    If you can eat healthy/spend more time with the kids/keep the house clean without having to bring out the guilt it would be much better.

    I say this with the thought of my own wasted sunk costs. Now when I think of them I only feel the guilt of not being all I intended to be. Now I have to remind myself of the very sunk cost concept-- that it's too late-- just let it go and be happy!

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    1. I love your take on this concept, wondrouslyweird. Guilt (and regret) really are the root drivers of the sunk cost fallacy, at least at the emotional level. We might be playing with fire.

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