One of the classes I had to take
in college for my accounting degree was Managerial Accounting. The class
taught us how to measure and analyze manufacturing costs for individual
businesses. If an accountant (or entrepreneur) miscalculates these
costs, the business stands to lose a lot of fungolas (the word Gary
Halbert used for money).
You may think you’re making fungolas when the reality is you’re losing fungolas.
class was probably the most practical course I had throughout my four
years of college. There’s one concept from this class that is critical
for you to understand and apply to make better investment decisions.
And I should issue a warning with regard to this concept… it’s not easy to apply because of how we’ve all been trained to think about investing.
The concept is referred to as SUNK COST.
Sunk Cost is a cost that has already been incurred and cannot be
recovered. After you make an investment, the price you paid for the
investment becomes meaningless. It’s a sunk cost because the money is
gone, and in most cases, cannot be recovered for the same purchase
As an example,
let’s say you buy 10 shares of Amazon stock at $2,000 per share for a
total investment of $20,000. Once these fungolas leaves your account,
you need to forget the $2,o00 share price. By ignoring the share price you paid for these shares, you actually make better investment decisions.
You’re forced to evaluate your investment with current market values. If the market value of Amazon drops to $1,600 per share, you’ve got to ignore the $2,000 you paid because it’s a sunk cost.
You have to decide the best course of action with your Amazon shares
based upon the new $1,600 market value. This makes sense intuitively;
however, we don’t think this way normally.
we look at this investment, we are trained to see the $400 (per share)
loss. We tend to make all of our decisions around the initial $2,000
purchase price, which is actually irrelevant.
best strategy when evaluating any investment is to focus on the current
value, not the price paid. The price you paid is a distraction.
Understand this sunk cost occurs in EVERY investment.
you buy a single-family rental property for $100,000 and the real
estate market crashes, taking the market value of this home down to
$60,000, the same idea applies.
have to make decisions for this asset as if you paid $60,000, not
$100,000. The $40,000 of lost value is gone and it’s just a distraction
that will impact your decisions with regards to this investment.
the way, this is actually what happened here in the States back in
2008. Many investors, including myself, focused on the price we paid for
our real estate investments even though these prices became sunk costs.
We focused on the
original price and ended up selling our properties (short
sale/foreclosure) at the bottom of the market. This was a very costly
mistake for many investors. The best investors ignored their purchase
prices and made decisions based upon current values.
asked themselves if they would buy the same asset for $60,000 now. If
their answer was “yes”, they kept their real estate investments. If
their answer was “no” they wouldn’t buy the same asset at the lower
price point, they sold the property.
BIGGEST investment mistake was buying an 8,000-square-foot commercial
building in a depressed area. I paid $550,000 for the property at the
top of the market. When the market crashed, the value of this building
dropped significantly because we lost three long-term tenants. There was
zero demand for commercial office space in this area, and the building
was hemorrhaging cash. The mortgage payment, property taxes, insurance
premiums and ongoing maintenance expenses were killing me.
a few years of dealing with this, I happily sold the building for
$125,000 in a short sale. When I drive by this property, a big smile
instantly appears because I no longer own that horrible investment. That
was my favorite real estate sale and I lost a lot of money! LOL
wouldn’t buy that building today for $125,000. Hell, I wouldn’t buy
that building for $100 because there’s still no demand for office space.
On a high level, as Cashflownaires
we don’t invest for appreciation so our purchase price of an asset
really doesn’t have much impact on our decision making process. We
invest for cashflow, and because this is our focus, we make decisions
around future cashflow.
Will the future cashflow of this asset be attractive?
If the future cashflow will be impaired for any reason, sell the asset
and take your loss. Move on to a better income-producing asset. The
price you’ve paid for the asset really shouldn’t be part of your
Yes, this is easier said than done!