Let's make a thought experiment.

Try to remember the last time you went to the cinema to watch a movie, and after a few minutes you realized the movie was horrible.

What did you do after?

I bet you stayed and endure the horrible movie until the very end because you already paid for it.

If that's the case, you fell into the sunk-costs trap.

A sunk cost is a fancy word economists use to indicate any money you already paid and you can't recover.

The interesting part is that our mind doesn't process sunk costs in a super-rational way.

Let's go back to the cinema example: admit to yourself you made a mistake is not nice, and you feel you have to stay until the end because you paid for it.

But the ticket you paid for is a sunk cost.

The money you paid is not coming back if you stay until the movie finishes.

Not only you already lost your money and you cannot have it back, but you are still losing your time, watching something you don't like instead of doing something more interesting for you.

How can the sunk costs make you lose money?

This kind of approach is very dangerous when you invest your money.

Let's make an example using real estate.

You buy a property that needs some work and you start investing money to renovate it.

Your target is to make it better and resell it at a higher price.

After a few months, you realized that the location of your property is horrible and nobody wants to live there.

Now you have two options:

1. Spending even more money and time to make your initial idea work (and hoping to make a small profit/losing less money).

2. Accept you made a wrong call, sell the property at a loss and use that money to buy a better property somewhere else or to change from real estate to financial products.

Even if it is painful, going for the second option will let you save more money and time that you can use for something more worthy.

How can you avoid the sunk costs trap?

There is no silver bullet, unfortunately.

Being aware of this trap helps, but in some situations, there is such a strong emotional component that can make you fall in the trap even if you know it's not the right thing to do.

All because your guts say otherwise.

What helped me is being comfortable with being wrong.

We have to take decisions without having all the information we need.

Or we have so much information we need to decide what to filter out, so making wrong calls is part of the learning process.

Once I became more forgiving with myself about being wrong, changing idea was not so painful anymore.

Like magic, falling into the sunk-costs trap happened less and less.

The bottom line: don’t stay stuck in a cinema the next time you find a horrible movie!

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