HOW MUCH WOULD you pay for $10? Taking my cues from a game developed by economist Martin Shubik, I’d offer to auction off a $10 bill to my high school students. There were three rules:
I ran such auctions for 20 years and it almost always had three stages.
Phase 1: Many students dabbled with bids in increments of five or 50 cents, slowly inching the price up.
Phase 2: The dabblers dropped out and only the “serious” players remained, usually getting the price up to $5 or $6.
Phase 3: The trap springs. Misha bids $6. Ben counters with $7. Misha, realizing she’s looking at paying $6 while getting nothing back, is forced to outbid Ben and goes to $8. Ben decides to finish it by bidding $9.99. Misha does some quick math and decides to bid $10 to break even, rather than pay $8.
But wait, there’s more. Ben surprises the other students by bidding $10.01, rationally deciding it’s better to lose a penny than $9.99. Misha now faces the same dilemma, and so it goes on.
At some point, I call the auction off and, despite my teacher salary, tell them no one has to pay me. I ask Misha and Ben to describe how they felt, which almost always includes feelings of regret and being trapped. They were no longer bidding to win, but to minimize their loss.
This exercise is a great way to introduce students to the sunk cost fallacy. What’s that? It’s the spending trap that—once you start down a path by putting money into a venture—you feel compelled to see it all the way through, lest you’ve wasted the initial outlay. It’s “throwing good money after bad.”
Funnily enough, the British have an opposite expression, “In for a penny, in for a pound,” which means you show determination by sticking it out, no matter what. That can achieve great things, but it can also be a lot of wasted pennies—which could have gone toward buying an ale to celebrate losing only one penny.
The sunk cost trap is everywhere because we’re taught that successful people never give up, winners don’t quit, and the best solution is to never regret and never retreat, but instead always move forward. Unfortunately, this can also lead to prolonged failure, such as when decision-makers—who have invested financial, political and personal capital in a course of action—refuse to acknowledge that the time has come to cut bait and find another fishing pond (or try golf instead). A classic example: the Vietnam War.
Back in 2019, a seeming lifetime ago, my wife Jiab and I went to the beautiful seaside Spanish village of Almuñecar. Located on the Costa Tropical of Spain, it’s one of those movie-like places with white-washed houses with Moorish accents and long sandy beach buffeted by the azure-blue Mediterranean. We loved the place for ourselves, but also learned it was just starting to be discovered by tourists coming to Spain for vacation, especially from Scandinavia. We immediately decided to look into buying a place that we could use occasionally for our own getaways, but mainly to generate holiday rental income to supplement our retirement. We found a place close to the beach and, by early 2020, we had settled on a price and put down a deposit.
In Spain, there’s a quaint custom that real estate deals aren’t finalized until all parties meet with a notary, who reads the document aloud and signs off. This is left over from centuries ago when people were illiterate, so the notary ensured all parties understood what they were signing. Today, it’s a pro forma (and expensive) ritual that seals the deal.
Only we didn’t get to it.
COVID-19 hit and, as many remember, Spain went into total lockdown. All meetings were put off, so we sat in our home in Granada and waited to finalize the deal. And waited.
Of course, our first priority was to do our part to stop the spread of COVID, so we stuck it out at home. As the situation remained in stasis, and the news everyday foretold a “new normal” coming, Jiab and I started reconsidering the house purchase. For ourselves, there was no foreseeable time when we’d be allowed to go to the new place. Even more, no one was sure when—or even if—tourism would come back, so the prospect of the new place being a positive money-generator evaporated. There were even stories that groups were seeking out unoccupied homes and taking them over as squatters, often trashing the place.
On the other hand, we had already sunk a lot of money, time and effort into researching Spanish real estate, finding the place and negotiating a price. We had paid a lawyer both to translate for us and guide us through the process. We had a deposit that was partly nonrefundable.
We ended up letting the place go. We cancelled the deal from our Granada home, informing the seller that he could keep the nonrefundable portion of the deposit. We wired payment to our lawyer and then reluctantly accepted that we were out of pocket, with nothing to show for it.
Except we had escaped. We didn’t have to worry about squatters living in our rental property, or closely monitoring an inaccessible home, or fighting with others for the scraps of tourist dollars that were trickling in. We also realized how lucky we were, as we fretted about losing a second home, while many today are in fear of losing their primary one.
I suspect others are facing similar tough decisions, as COVID changes the entire financial lay of the land. It isn’t a bad idea to think about what ventures, investments and dreams we might be better off walking away from, or at least putting off for the moment, no matter how much we’ve already put in. Perhaps we should save what we still have, so we can spend it another day.
After all, $10 isn’t what it used to be.
Jim Wasserman is a former business litigation attorney who taught economics and humanities for 20 years. His previous articles include Choice Words, A Poisoned Chalice and Falling for Flattery. Jim is the author of Media, Marketing, and Me, about teaching behavioral economics and media literacy, as well as Summa, a children’s story for multiracial, multi-ethnic and multicultural families. Jim lives in Spain with his wife and fellow HumbleDollar contributor, Jiab. Together, they write a blog on retirement, finance and living abroad at YourThirdLife.com.