Why Your "Mental Accounts" Are Costing You Money

Second Level Thinking · Issue 30

Examining the sunk cost fallacy and how we organise our lives. Plus, why strategic laziness is a required form of founder discipline.

Vince paid $1000 dollars to a tennis club that entitled him to play once a week for the season. After two months he developed tennis elbow, which makes playing painful. He continued to play in pain for three more months because he did not want to waste his membership fee. He only stopped playing when the pain became unbearable.

When an amount of money has been spent and the money cannot be retrieved, the money is said to be sunk, meaning gone, writes behavioural economist Richard Thaler in Misbehaving: The Making of Behavioural Economics. Sunk cost fallacy, or the analogies between the world of accounting and the mental accounts we use to organise and run our lives (with results that vary from foolish to very helpful), is a topic that Thaler has been fascinated with for decades, writes Daniel Kahneman.

We like to think the cost doesn’t matter but psychologically it’s hard to ignore. To make things clear, if a friend invited Vince to play for free at another club, he would say no as a result of his injury. In economics lingo, this means the utility of playing tennis is negative, writes Thaler.

Sunk costs linger and not just gym memberships and concert tickets that you pay for but fail to utilise. Many believe the United States continued its war in Vietnam because they had invested too much to quit. But why do sunk costs matter? And why might people think that continuing a course of action is worth it?

When you make a purchase at a price that does not produce any transaction utility, you do not feel the purchase price as a loss. You have paid some money, and when you consume the product you will get the pleasure of the acquisition utility and the amount will clear; your earlier cost is canceled out by your later gain. But what happens when you buy the concert ticket and then skip the event?

Paying $100 dollars for a ticket to a concert that you do not attend feels a lot like losing $100 dollars. In financial accounting terms: when you buy the ticket and then fail to use it you have to “recognise the loss” in the mental books you are keeping. Going to the event allows you to settle this account without taking a loss. Similarly, the more you use something you have paid for, the better you feel about the purchase.

Think about it: Things we acquire and consume frequently, whether it's your favourite t-shirt, handbag, or pair of shoes result in a much happier purchase decision upon reflection than ones where you realise you don’t like the product after returning home. Furthermore, the more you have paid for the shoes, the more you will force yourself to wear them even when they hurt your feet before giving up.

Many have unused gym memberships that haunt them and studies conducted by Gourville and Soman have found that when a membership is structured with a biannual payment, attendance jumps the month after the payment is made and then slowly fades again. They called this phenomenon “payment depreciation,” meaning the effects of sunk costs wear off over time.

Personally, I have experienced examples of this recently and concluded, I find monetary sunk cost easy to account for, and effort based sunk cost immensely difficult to account for.

I could not attend a concert I had paid for recently and was frustrated momentarily, but I reconciled the sunk cost extremely quickly, in moments. On the other hand, I had a business venture that I had done a lot of research on and felt really, really difficult in letting go. I was genuinely frustrated at the effort I had put into it without any reward and wanted to keep clinging to it, almost doubling-down as a result.

Isn’t it funny how in severe instances we can resort to self-sabotaging behaviours in a way and trick ourselves into committing more time to something that will not amount to anything. You double-down out of frustration, rather than cut your losses and move on. “I’ve invested so much, I can’t quit now,” is a common phrase.

How Long Does a Purchase Linger?

In some instances sunk costs and opportunity costs can be intertwined and one paper Thaler produced was centred on the question: “how long does the memory of a past purchase linger?” The study was run using subscribers to an annual newsletter on wine auction pricing and it goes something like this:

Suppose you bought a case of good Bordeaux wine in the futures market for $20 a bottle. The wine now sells at auction for about $75. You have decided to drink a bottle; which of the following best captures your feeling of the cost to you of drinking the bottle?

1. $0. I already paid for it. (30%)
2. $20. What I originally paid for it. (18%)
3. $20 plus interest. (7%)
4. $75. What I could get if I sold the bottle now. (20%)
5. -$55. I get to drink the bottle that is worth $75 that I only paid $20 for, so I save money by drinking the bottle. (25%)

(The percentage of respondents who chose each option is listed in brackets).

They included option (5) as a joke and were not sure anyone would select it, yet 25% of participants’ mental accounting was so sophisticated they saw it as an act that saved them money! The correct answer according to economic theory is $75, since that is the opportunity cost of selling the wine in the current marketplace.

Someone else said if the wine they bought doubled in price, they would sell half and then drink the other for free! Brilliant. But there is a disparity in the outcomes, as in another survey many saw the purchase of wine to store as an ‘investment.’ Obviously, you cannot have the acquisition being made for financial gain, yet the consumption of it after-the-fact being it either costs nothing, or saves you money which highlights the various beliefs and accounts we each hold.

Although I mostly support thinking like an economist, when it comes to mental accounting, I have many human tendencies. As I mentioned earlier, I am usually ok with ignoring sunk costs that are purely monetary in nature. But, like most people, if I have put a lot of work into a project, I find it difficult to let go, even when it’s clearly the appropriate thing to do.

In the writing landscape, this is likened to a phrase often attributed to William Faulkner in that one must learn to ‘kill your darlings.’

So, in closing, is there a sunk cost you are holding onto and need to let go?

Parting Shot

What? The most effective people are "lazy" about the things that don't matter.

So What? High achievers are taught to care about everything. To do it all. To push harder. But often, the real breakthrough comes from doing less, strategically. Elite performers don't pour energy into every task. They underperform on purpose in areas that don't move the needle. They ignore, eliminate, or automate what others obsess over. Not because they're careless but because they're clear. Strategic laziness is a form of discipline. It's how you reclaim your energy from the trivial and reallocate it to what actually moves you forward.

Now What? Pick one task today you're doing well that doesn't deserve your best. Stop doing it, delegate it, or do it with 80% effort. Reinvest that energy where it counts.

— Greg McKeown