• Zack Gutches

The Sunk Cost Fallacy and The Next Right Thing

During my downtime amidst this quarantine, I've been [semi] binge-watching the TV show "Better Call Saul". For those unfamiliar, it's a backstory on one of the main characters (Saul Goodman, a loud-mouthed lawyer) of the hit TV series Breaking Bad, starring a fellow Idahoan, Aaron Paul.

In Better Call Saul, Saul worked in a mail room while he put himself through law school -- doing classes at night (which, by the way, he didn't tell a single soul about). After years of doing this, he finally passes the Bar and becomes a licensed attorney. However, not shortly after, circumstances lead him to believe he should "quit the law". So he checks himself into a 5-star hotel and spends a week sipping long island iced teas while tanning on his pool floaty.

After about a week, Saul's colleague/girlfriend (it's complicated) confronts him and tells him how he can't quit the law because he's poured so much time, energy, blood, sweat, and tears into becoming a lawyer and getting this far. Saul's response is what I want to focus on in today's post. He says "It's a sunk cost. The sunk cost fallacy is what gamblers do. They throw good money after bad, thinking they can turn their luck around."

During times of uncertainty (or maybe for you it's certainty that some things are going down the toilet right now), it's easy to chase after something that's bad or wrong, in the name of a principle that is flawed (but doesn't appear to be because of emotional investment on our part). Let me give an example with investing (and I've fallen prey to this one more than once):

You buy a stock you love and believe in. 6 months later, the stock is down 10%. So you buy a little bit more on the dip, hoping for a rebound. 6 more months pass, and now the stock is down another 10%. You buy some more because you believe in the long run the stock will set new record highs, and you believe in the company and their mission. Another year goes by and now the stock is down a whopping 50% from where you originally bought it from. What do you do now? And how do you approach making this decision? What was once an objective, and fairly easy investment decision has now become convoluted. For me (and I'm guessing for some of you), you bought more after the stock dropped 50%. And it wasn't because of promising looking RSI or MACD or OBV (technical indicators used in finance) or favorable fundamental analysis. No -- it becomes about recouping your losses and chasing to "get back what's yours". Out of principle, the stock should have rebounded, but it didn't. Your decision is an emotional one now -- buying out of spite rather than belief and objective judgment. Your focus has shifted from whatever your original intent was to "getting even" or solely focused on "getting back what you lost".

This is a classical example of the sunk cost fallacy in action. The past is a "sunk cost" -- it's gone, it's done. All you can do is to "just do the next right thing" (thanks Frozen 2).

This happens with many people in their mid-to-late 20's with respect to their career. They spent 5+ years getting a master's degree in accounting, got their CPA license, and after 3 years working in accounting, they realize they hate it. And it's so hard for them to move on to something else because they've put so much into getting where they are. But guess what? They have another 35+ years of working ahead of them! Don't let the past unduly influence how you proceed forward. The past oftentimes needs to be viewed as a sunk cost in your decision making.

So let's apply this over to money. In your finances, what is something that you're letting the past cloud your judgment of the "next right thing"?

Maybe you gave your money to a pushy salesman at *insert financial institution* and you don't even like him/her and paid him/her 4% of your 401(K) up front and feel like since you already paid them 4%, you should just keep the money there even though you don't think you're getting the best service.

Maybe you prematurely bought a house and got over your ski's a bit on what you could actually afford and are struggling to pay your mortgage and property taxes and insurance and maintenance during this hardship. You know you can't continue to make payments without wrecking havoc on the rest of your financial situation, but you know how much work it's going to be to sell the house and get in a place you can comfortably afford.

Maybe you feel stuck in your career because of how financially rewarding it is -- even though you hate it! You worry that if you try and switch over to doing something you enjoy and take a 30% pay cut you won't know how you're gonna make it financially.

In all of these situations (and whatever yours might be) -- remember that oftentimes the past is a sunk cost -- what you really need is to find your "next right thing".

During times of [financial] hardship such as now during the Coronavirus, gaps in your own "financial planning" can often be exposed. Things don't pan out the way you thought, or intended, or even imagined were possible. A lot of "how did I get here?" thoughts begin to surface -- and an adjustment is necessary -- and you know it. So let me encourage you when figuring out what your adjustment needs to be -- consider what needs to considered, and ignore what needs to be ignored.

I want to end by saying that I am here and available to help you navigate your financial life. Please take advantage of the free 25 minute consultation call if you just want somebody to talk to about your situation. I'm here to help.

P.S. -- I've been getting some questions about how the $1,200 rebate will affect your 2020 taxes. The $1,200 (or $2,400 if you're married and entitled to the full amount) is being issued in the form of a refundable tax credit, which means it is not taxable income to you. It also means that if you made a lot of money (>$100,000 single, >$200,000 married) in 2018 or 2019 (whatever year your latest return was filed) and your income will drop substantially in 2020 (<$100,000 single, <$200,000 married), you will ultimately "get" $1,200 (because your taxes will be lowered by $1,200 through the refundable tax credit) -- you just won't get the benefit until you file your 2020 taxes in the spring of 2021.

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