What is Sunk Cost?
A sunk cost is any past expenditure that cannot be recovered regardless of future actions. In investing, the purchase price of a stock is a sunk cost once the transaction is complete. Rational decision-making should be based only on future expected returns, not on what you originally paid. Yet the sunk cost fallacy, the tendency to continue an endeavor because of previously invested resources, is one of the most common cognitive biases in investing.
The Sunk Cost Fallacy in Practice
A classic example is holding a losing stock because selling would mean admitting a loss. The original purchase price is irrelevant to whether the stock will rise or fall from its current price. Another example is continuing to pay for a subscription or service you no longer use because you have already paid for several months. In both cases, the money already spent should not factor into the decision about what to do next.
Key Considerations
Overcoming the sunk cost fallacy requires asking: if I did not already own this investment, would I buy it today at the current price? If the answer is no, holding it is irrational regardless of your purchase price. Setting predetermined exit criteria before entering a position helps remove emotion from the decision.