For some reason the aphorism “don’t throw good money after bad” reminds me of an oil wildcatter drilling a test well. After all,
oil drilling involves creating a hole in the ground—something I associate with a similar saying, “don’t throw money down a rat hole.”
Our oil wildcatter, having done his research, knows that there is a 50% chance that he will strike oil at a depth 500 feet or so. He also knows that if there is no oil at 500 feet, there is a 12% chance that there will be oil at a depth of 800 feet. The wildcatter will have to spend $10,000 for each 100 feet he drills.
Five hundred feet and $50,000 later, no oil has been found. What should our oil wildcatter do? If he drills further and finds oil, he will recoup his investment. Of course, there is an 88% chance that the hole will still be dry, and a 100% chance that he will spend another $30,000 to find this out. For an impartial observer, the choice is clear. The wildcatter should stop drilling.
Any observer of life knows the basic rule, which states that we should not take irrecoverable or “sunk” costs into account when making decisions about our present or future investments. However, we break this rule all the time, succumbing to the cognitive bias known as the “sunk-cost fallacy.” The sunk-cost fallacy is when one has incurred costs that cannot be recovered and we reason, ” I can’t stop now, otherwise what I’ve invested so far will be lost.” Our wildcatter can choose between the following two end results at the point of reaching 500 feet and having not struck oil. He can
- Accept that he has paid $50,000 on a dry hole and choose to invest $30,000 more, drill further in the hope that he will find oil at the 800 foot depth and recoup his investment, or;
- Accept that he has paid $50,000 on a dry hole, and choose to walk away—and save the remaining $30,000 for a better day or a new investment.
However, he has to accept the fact that he just spent $50,000 on a dry hole. This is not an easy fact to accept. But it is critical to making a good decision.
This is just a basic overview and is not legal advice specific to your situation. If you would like to speak with Jonathan about your situation, please email him at jcw@eastbaybusinesslawyer.com or call him at 925-217-3255.
