Sunk Cost and Getting Your Money’s Worth

March 23, 2009 by TFB

I went skiing last Saturday. The condition wasn’t great. It was windy and cold. I knew that before I went, because I read the weather forecast. I went only because I bought a season pass last year before the season started. If I didn’t have the season pass and a friend offered me a free ticket, I would’ve chosen not to go because of the bad weather, and because after a busy week at work and working on a new initiative in the evenings, I would prefer sleeping in. But I still went. I wanted to get my money’s worth. Did I not know the cost of the season pass is a sunk cost? I did, but I still wanted to get my money’s worth. It’s hard to explain rationally. I admit I’m not rational.

This reminds me a story about economist Harry Markowitz. Harry Markowitz is the father of modern portfolio theory. The concepts of portfolio diversification and efficient frontier came from that theory. He won a Nobel prize for it. When it came down to making the decisions for his own portfolio, he said,

“I should have computed the historical co-variances of the asset classes and drawn an efficient frontier. I visualized my grief if the stock market went way up and I wasn’t in it — or if it went way down and I was completely in it. So I split my contributions 50/50 between stocks and bonds.” – source

In the end, we are all humans. We’ve got to do what feels right to ourselves.

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Comments

2 Comments on Sunk Cost and Getting Your Money’s Worth

  1. Pelon on March 23, 2009 | permalink
    2.  

    The rationality of a decision depends on our perspective. From a financial point of view, it may have been an irrational decision because it cost you additional time and money for something that did not have a lot of value to you.

    From an emotional perspective, however, I would say that the emotional value to you of "getting your money's worth" was greater than the value of the additional cost in time and money. This must have outweighed the financial considerations, or you wouldn't have gone. Either that, or you were temporarily insane. :)

    In short, money isn't everything.

  2. mudfud on March 24, 2009 | permalink
    3.  

    Interesting! The notion of sunk loss was not self-evident to me, until I read about it. Since then I have made multiple "rational" decisions based on sunk loss, and I think it has become so deeply ingrained in my psyche, that it easily overcomes what seems "intuitive". So I think it's a matter of practice and reinforcement.

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