IN THE RED

When it comes to establishing a new habit, activity or investment, oftentimes the most difficult part can be the first step.

When an individual or a business is “In the Red” (i.e., running a deficit or cash flow negative), there is an intense effort just to survive. It is a unique version of pressure when there are only two possible outcomes, survive or die.

The “In the Red” mindset is a close relative of the “burn the boats” strategy of ancient leaders and generals. In recent history, numerous companies have been cash flow negative only to become wildly successful and profitable.

Two instances in my own life in the recent past offered perfect examples of the motivation created from operating from a deficit.

I bought a new pair of shoes to motivate me to work out. The $100 for the shoes did not magically make me want to go to the gym. They did however make me feel that going to the gym was necessary to justify the purchase.

A few days later, I paid someone with a successful newsletter for an hour of time to teach me about starting my own newsletter. This phone call put me in a position where I had to start a newsletter or else admit that I wasted my time and money.

Both actions put me “In the Red” but simultaneously motivated me to head to the gym each morning and to start a newsletter..

Although I am not an expert when it comes to behavioral economics, it seems that paying for the shoes and advice are examples of the sunk cost effect. Below is a formal definition of the “Sunk Cost Dilemma” from Investopedia, a widely used resource for investors.

“The Sunk Cost Dilemma is a formal economic term that describes the emotional difficulty of deciding whether to proceed with or abandon a project when time and money have already been spent, but the desired results have not been achieved.”

It is easier to keep going once an investment of money, time, and/or effort has been made. The human mind quickly and easily justifies any required, extra contributions once the initial investment has been made.

Typically, the effects of sunk costs are considered to be negative. Many point to sunk costs when it becomes clear that one’s effort proves to be ineffective. They should not be considered in a series of cash flows and should not be expected to provide any future benefit. The typical narrative around sunk costs is succinctly described, “Don’t throw good money after the bad, just cut your losses and move on!”

This description has been fueled by failed entrepreneurs and business plans, corporate R&D budgets, monthly rent payments, and many other examples. Just search “examples of sunk costs” and you'll find tons of negative commentary on the topic. In my search, I do not see a single positive article or example on the first page of results.

Are all examples of a sunk cost inherently negative? I would say no.

The two examples described earlier both resulted in positive outcomes in my own life. The initial investment in shoes resulted in a month’s worth (and counting) of visits to the gym. I can never recover the first money poured into the newsletter consultation, but it could result in countless future articles/posts.

These two circumstances were, in part, intentional efforts to create a sunk cost. Because the mind generates additional intensity and commitment when “In the Red,” a sunk cost can be a useful tool.

When starting a business, thoughtfully spending the proceeds of an SBA loan can be the kicking off point of a successful venture. Although corporations may misallocate portions of the R&D budget, it is necessary to ignite innovation. On a personal level, friends and relatives may drone about “throwing away your rent payment” every month, but the flexibility of renting may allow for more travel or saving/investing.Sunk costs might be commonly accepted as negative outcomes, but it does not mean you can't use them to your advantage.___________________________________

As an individual or a business, operating “In the Red” is probably not the ideal or desired outcome. That being said, there are many instances where a thoughtfully applied sunk cost can create needed pressure and motivation, resulting in an outcome that would not have been achieved otherwise.

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Reply and send me an email about the positive outcomes due to sunk costs in your own life.