Everyday we have to make decisions. When to get up in the morning; what to eat for lunch; whether to buy that new TV or not. Not every decision is life changing, but it’s the sum of all these decisions that will determine our future. I’m not going to go into a long random spiel about decision making, but I want to mention one principle, the concept of sunk costs.

Sunk costs are those which have already been incurred and which can’t be recovered. These costs are in contrast to variable costs which will change from one proposed course of action to another.

This concept is important to understand because it helps to keep us rational when we’re dealing with financial decisions. Money that has already been spent should have no bearing on our future choices. It’s a matter of letting the past be the past and moving forward.

Suppose you’ve been taking music lessons for a couple of years, and you’ve more recently decided that music isn’t really your passion. You should choose whether or not to continue with the lessons based on your interests and desires. Many would reason that since you’ve “invested” so much time and money already you should continue taking lessons.

This concept should also be applied to investing. If you’ve bought an investment and it has unfortunately lost money, you shouldn’t stick with it just because you’ve already put the money in. The investment should be re-analyzed and either kept or sold based on whether it is still a good investment or not, not just because you’ve already spent so much on it.

Not every decision we make will, or even should be, rational; however, when it comes to our finances, the concept of sunk costs is an important one to understand and keep in mind.

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