I came across this little gem of an article called Sunk Cost Bias on a blog called Litemind, and I immediately thought of how applicable it is for a real estate investor. Not that long ago Dave was suffering from a sunk cost bias of his own… he’d bought a crackhouse in Niagara Falls, ON.
Year after year it cost us money and added a lot of stress to our life. Within the first few years of owning it our property manager went on trial for murder, Dave was fined in court about fire code violations, and Dave had to constantly make repairs to keep it up to fire code.
He tried to sell it a few times. But he priced it too high to attract buyers as he wanted to at least get his money back. Finally this year he accepted that it didn’t matter what he had paid for it, he had to get rid of it. He lost money when he sold it but it was such a relief it didn’t feel like money lost.
The price you paid for your house is really irrelevant for most things except calculating capital gains or losses. When you go to sell your house, the only thing that matters is what the “market” is willing to pay for it. It doesn’t matter if it would cost twice as much to build that house. It doesn’t matter if you paid $1 for it or $500,000 for it. All that matters is what someone will pay for it today. When I look at our investments I don’t think about what we paid for each of them, I think about whether the property fits within our investing goals today. If it does, then I keep it. If it doesn’t, then I begin evaluating options.
As the blogger of Litemind points out, money spent and time invested are in the past. Failing to leave that dead end job, walk away from that bad relationship or not selling that stressful money sucking property just because you’ve invested so much in it and want to make it pay off is just “throwing good money after bad” or good energy after bad.
I really like the advice in the blog that says:
Sure, we all expect to have a good return on what we invest. It would be insane not to. Just make sure you’re not on a situation solely because you made the investment in the first place. You don’t make a bad move any better by dwelling more on it, unless you can effectively make something that changes the expected outcome.
Stop spending resources on a bad move — throwing good money after bad — immediately and start spending these resources on a new one: Cut your losses and move on!