In your personal and professional life, finances will play a huge role. Since our childhood, we are taught to avoid losing more money than really necessary. There are times when money is going to be lost, whether you are responsible or not. There is no way you can avoid the cost. Hence, the best way is to understand how it affects your finances and prepare for them. Budget around the costs and handle your finances efficiently. Let us understand what is a sunk cost.
What is sunk cost?
A sunk cost is the expense that has been paid for and it is not possible to recover in any way. Since the cost cannot be retrieved, it should not factor at all in the financial decisions you make for the future. This money has been spent and should not be considered in the next budget. It is very similar to a situation where the business is failing and your only option is to shut it down. This is how you can cut losses. It is important to understand that saving money in sunk cost means to avoid losing additional money.
The money already used cannot be recovered in any case. All costs may or may not be sunk which is why looking at the specifics can make a huge difference. For example, you have equipment in the business. The cost of equipment is sunk but if you want to replace it, you can sell the parts of the equipment and make money out of it. You will not get back anything close to what you paid for it at the time of purchase but you will still get some amount out of it.
Sunk cost in personal life
A sunk cost is not always negative. At times it is only a payment that will not be refunded. It is a payment made without any expectation of having the money returned. An important theme with the cost is its inevitability. Some businesses need to update the equipment and they have to spend time and money on research. It is important to keep in mind that even the most successful businesses have to handle sunk costs.
The cost is also a part of your personal life. When you buy a movie ticket for $50 but you later realize that you cannot go for the movie, it is a complete sunk cost. After you pay the rent to your landlord, it is a sunk cost because you will not get the rent returned to you. However, the security deposit is not a sunk cost as it can be recovered at the end of the lease. There are several instances where sunk cost is applicable in your personal life. The sunk cost will happen in your life but you should know how to avoid them. You must understand and prepare for them.
Sunk cost fallacy
This cost in your personal life is often associated with sunk cost fallacy. It happens when you stick with a decision only because you have put money in it and want to ensure that it is not lost. It can have an impact on even the smallest financial decision you make. For example, you have purchased a concert ticket and you bought it well in advance. Later, you realize that you have an exam the next morning and you cannot attend the concert. But you have spent a huge amount on the ticket so you decide to attend the concert anyway. This is the sunk cost fallacy. Whether you go to the concert or not, you will not recover the amount and it does not play any role in your decision. Such situations often occur in businesses.
Impact of the cost on your finances
If you want to create an efficient budget, you need to take sunk costs into consideration. You need to identify the monthly expenses that fall into the category of sunk costs. You will have to decide whether it is better off to cut the losses on the cost or go forward with them and save the loss. If you notice that an amount has been used and you will not be able to recoup it, make a decision on whether you can bear the loss or you want to make the most of whatever you have spent.
Give it careful consideration because it can involve far more money in the long run. Be aware of the expenses you regularly incur and the ones that fall into sunk costs. They are going to happen once in a while. Your responsibility is not to avoid them completely but to budget for them in advance. Consider salary, rent, utilities, and other expenses when you create a budget. Whenever it is possible to avoid the costs, you need to do it.