How to do a Sunk Cost Analysis in your Financial and Personal Life

A great advantage and a great drawback about human nature is our ability to think emotionally. While thinking emotionally is important for dealing with your relationships, it can harm you financially in some situations. A sunk cost analysis is a mental exercise you can do to emotionally detach yourself in some financial decisions (such as to buy or sell something), and discover what a rational decision might be.

	The first step is to recognize that the amount you paid in the past should not affect current financial decisions. That is, the cost of whatever you did or bought is "sunk". Only the current value of the item is relevant.
	Now, formulate your decision into an either/or question between your current situation and the alternative. If there are many choices, take them one at a time.
	Put yourself mentally in the situation that you are not in now. Ask yourself, pretending you were in the other situation, if you would go back to the current situation. If you would go back to your current situation, then stick with your current situation. If not, make the decision to change situations.
	To make the steps clear, the remaining steps are all examples. The classic example is the following. You are at a movie theater and you just paid $10 for a ticket. Just then, a friend rushes in and tells you some things about the movie that make you realize you won't like the movie. Also, your friend is going bowling now and invites you along, which you enjoy far more. An emotional thought might be "I should go to the movie since I did pay the $10." However, the money has already been spent and it is gone, no matter what you do. If you were currently with your friend going about to go bowling, and someone told you there is a movie you would hate for free at the movie theater (free, since you already paid for the ticket and the money is gone), you would not go to the theater, but rather you would go bowling. Therefore, you should throw out your ticket, and hang out with your friend instead.
	Suppose that you owe $100,000 on your home mortgage and that is your only debt. You just inherit $100,000. Your friends tell you to invest the money in the stock market to get great returns, but you've been wanting to pay off your home mortgage early. Which do you do? In this case, you ask yourself, if you had a paid off house, would you go to the bank and borrow $100,000 to invest in the stock market. The likely answer is that you would not, so instead of putting the money in the stock market, you pay off your house.
	Suppose that you are moving out of town and are trying to sell your house, but prices are low, so you aren't getting what you want. Let's say you can realistically get $200,000 for your house, but you think it might go back up to $250,000 in a couple of years. You consider renting the house and holding onto it for two years. Should you do it? Again, imagine that you didn't own the house and you already lived in the other city. Then imagine that a house came up for sale in your original city for $200,000 and you think that that same house would also increase to $250,000. Do you go out and spend/borrow $200,000 to buy a house in another city to be a remote landlord and wait for the value of the house to go up? Probably not, so then you should accept a $200,000 offer in the sale of that.

• Remember that a house is a house, not a home. It's the people in the house, not the house itself that make it special.
• Remember that there are plenty of cars out there. If you have to sell your favorite car in the whole world, there are probably thousands with the exact same trim, color, mileage, etc, and if things change, you can always get it again.