Sunk Cost Fallacy
The Sunk Cost Fallacy is the tendency to continue investing time, money, or emotional energy in a failing course of action because of prior irrecoverable costs, rather than making decisions based solely on future expected outcomes.
In rational economic theory, sunk costs — costs already incurred that cannot be recovered — are irrelevant to forward-looking decisions. Only marginal future costs and benefits should influence whether to continue, expand, or exit a position. In practice, however, prior investment creates a powerful psychological anchor that makes abandonment feel like waste, causing people to throw good money after bad.
In equity markets, the sunk cost fallacy typically appears when investors refuse to exit a declining stock because they have 'already lost so much' and want to 'get back to even' before selling. The original purchase price is a sunk cost — it cannot be recovered regardless of any future decision — yet it dominates thinking. The rational question is: given everything known today, is this the best use of this capital going forward? Sunk costs have no place in that calculation.
Corporate capital allocation is equally vulnerable. US companies have repeatedly continued funding underperforming divisions, failed acquisitions, or overbudget capital projects far beyond the point where rigorous analysis would justify discontinuation. The Concorde supersonic jet project is the canonical international example; domestically, numerous natural resource projects and retail expansion strategies have been sustained by sunk cost logic long after economic viability had evaporated.
The fallacy interacts with loss aversion in that cutting a losing position requires realizing a loss — triggering the pain that loss aversion amplifies. The sunk cost provides a narrative justification for avoiding that pain: 'I'll hold until I break even.' The breakeven point has no analytical meaning, but it serves as a psychologically comforting future event that defers the moment of reckoning.
Practical discipline requires a deliberate mental exercise: evaluate every existing position as if it were a new candidate for inclusion in the portfolio. If the position would not be purchased today at its current price, the sunk cost fallacy may be the only reason it remains held.