How To Rapidly Go Broke

Falling for the sunk cost fallacy

Photo by Nik on Unsplash

Back in the 1980s there was a movie starring Tom Hanks and Shelley Long called The Money Pit.

They play a young couple without a lot of money who want to buy a house. A con artist convinces them to buy a beautiful mansion for a low price. It seems like unbelivable good fortune.

However, there is a saying about how if it looks too good to be true…

The young couple, unfortunately, are gullible. They don’t have the place professionally inspected before they buy the property. And it turns out to be a money pit — hence the name.

When they realize the house is falling apart, instead of cutting their losses and leaving, they keep sinking good money after bad. This money was the sunk cost, and their assumption that if they just kept going things would improve is the sunk cost fallacy.

There are several important lessons the movie teaches:

• Inspect before you buy. I always had a mechanic I trusted check a car before I bought, had a house inspected professionally, etc.
• If you are losing money (or time) don’t keep adding to the sunk costs
• People are emotionally vulnerable to the sunk cost fallacy; this is a universal human trait

Even if someone knows intellectually that continuing to spend money in this type of situation is a bad idea, their emotions sometimes overwhelm their rationality and so they willingly make horrible decisions.

So, for example, instead of getting an inspector to come over immediately after the first couple of repairs, the couple kept spending their money without getting better information first.

It’s not just individuals who do this, either. Corporations, governments, school boards, charities, etc., can all do this. Sometimes they also double down and end up declaring bankruptcy.

Gamblers routinely do this, as do futures investors.

And this doesn’t just happen with money.

It can happen with the use of time and also with relationships.

Sometimes a person can be working on a project that is going badly. Instead of stopping and using their…