Father Sez

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Getting a grip on sunk costs when doing a personal finance makeover

Wednesday September 24th, 2008 by fathersez

One of my favourite personal finance blogs, Get Rich Slowly, had a great piece on the sunk cost fallacy. It’s truly good stuff and should be recommended reading for anyone of us intent on changing our personal financial positions. 

One common factor that should be present in almost anyone with a “not so good” personal finance situation would be some of the investments and purchases made in the past. Expenses that we thought (at that time) would be useful and pay for themselves   many times over. And many of these come with recurring costs. 

When we set out on changing our pf habits, these recurring costs are sometimes quite difficult to eliminate. The thinking that we have is…”Oh! We have already spent so much, how do we throw this away?”. So trapped in this thinking, we continue throwing away more good money after bad. 

Examples of these would be subscriptions to various clubs or societies for which we had earlier paid hefty joining fees, Timeshare purchases, purchase of a car with a high monthly instalment etc. 

GRS quotes from the book, Why Smart People Make Big Money Mistakes (and How to Correct Them). 

Once your money is spent, it’s gone. It has no relevance. To the extent you can incorporate that notion into your financial decisions, you’ll be that much better off for trying. If you’re debating the sale of an investment (or a home), for example, remember that your goal is to maximize your wealth and your enjoyment. The goal is not to justify your decision to buy the investment at whatever price you originally paid for it. Who cares? What counts, in terms of getting where you want to be tomorrow, is what that investment is worth today.

This is also a rule in management accounting, when financial evaluations are done to decide on issues like producing ourselves or subcontracting etc. Expenditure made and done with are ignored. The only things that matter are the future outflows. 

This was the rule that I used when we cancelled our club memberships (two of them) and our cable TV subscriptions. Now we have done the same with our Timeshare. Just cancelled the bloody thing and save the annual subscriptions that came with it. (Man, it did hurt! But time should heal all things). 

Sunk costs are just that. Costs spent and gone. Nothing that we do now will change that. What matters is what we would be spending in the future. Is it an expenditure that we  would make, now that we have a new mindset? Just ask yourself this. If the answer is no, then just cancel and be done with it.

I have.

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2 Comments for “Getting a grip on sunk costs when doing a personal finance makeover”

On September 28, 2008
At 10:56 pm

[…] did a great post on how to evaluate sunk costs. It’s important not to get caught up in the money you’ve already sunk in something […]

by Patrick
On September 29, 2008
At 2:31 am

Very true, fathersez. There comes a time when it’s best to cut ties, and go on without the expenses any longer. In addition to spending less money, cutting ties on those expenses can be a relief because you don’t feel any guilt when you think about what you are spending money on and question why you are still doing it.

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