Sunk Cost Fallacy: Why Past Losses Shouldn't Drive Future Decisions

Key Takeaways

• A sunk cost is any past expenditure that cannot be recovered, rational theory says ignore it and choose the best forward option.
• Arkes and Blumer's 1985 theatre study found participants who paid full price attended significantly more shows than those who received discounts.
• Treating past research hours, emotional investment, and attention as reasons to hold converts sunk costs into active position-sizing rules.
• The reframe: "If I had this cash today, would I buy this position at the current price?", the answer is independent of what you paid.

What It Is

A sunk cost is any cost that has already been incurred and cannot be recovered, no matter what you do next. Rational decision theory says you should ignore sunk costs and choose the action with the best expected outcome going forward. People routinely do the opposite.

Hal Arkes and Catherine Blumer documented the bias in a 1985 paper titled "The Psychology of Sunk Cost." Across several experiments, subjects continued failing projects, kept using things they had paid for, and inflated success estimates for efforts with higher prior investment. Their most cited finding came from theatre season tickets: patrons who paid full price for a subscription attended more plays over the following six months than patrons who received the same subscription at a discount.

The Intuition

Humans dislike waste. Walking away from money already spent feels like confirming that the spending was wasted. Continuing feels like giving the original investment a chance to pay off, even when nothing about the forward outlook supports that.

In investing, the bias becomes dangerous because position size often grows with prior losses. "I have already lost 30 percent, I cannot sell here" is not a reason to hold. The correct question is whether, starting fresh today, the capital still in the position would be better deployed in this security or somewhere else. The answer is independent of what was paid.

How It Works

Three mechanisms reinforce the bias. Loss aversion makes realising a loss feel disproportionately painful, so the decision maker prefers any scenario, however improbable, that avoids the realisation. Commitment and consistency push people to behave in line with past choices, since reversing course implies the earlier choice was wrong. Mental accounting treats the position as an open book that must be closed at breakeven or better to feel resolved.

Separating sunk costs from forward economics usually requires a clean reframe. The standard trick is to ask: if I did not already own this position, would I buy it today at this price? If no, the only reason to hold is the sunk cost, and that is not a valid reason.

Worked Example

Suppose you bought 100 shares of a company at 50 dollars per share. The thesis has since broken: a key product launch failed, guidance was cut, and the stock now trades at 30. Your paper loss is 2,000 dollars.

You have 3,000 dollars tied up in the position. A reasonable alternative use for that 3,000 is a basket of five sector peers you believe are fairly valued and growing. Arkes and Blumer's research predicts that you will hold the original stock longer than the forward case justifies, because selling crystallises the 2,000-dollar loss and acknowledges the original decision was wrong.

The sunk cost framing says: the 2,000 is gone either way. The only choice is whether the remaining 3,000 has a better home. The answer is determined by forward returns, not by what you paid.

Common Mistakes

1. Confusing sunk costs with real costs. Commissions, taxes, and bid-ask spread you will pay on the exit are real forward costs and belong in the analysis. The price you originally paid is not. Only the first set should influence the decision.

2. Applying sunk-cost logic to exit too early at breakeven. The mirror mistake. A position that recovers to breakeven is often sold out of relief, as if the original cost had become "recoverable." That is also letting the anchor drive behaviour. The current forward case is what matters, whether the position is up, down, or flat.

3. Confusing opportunity cost with sunk cost. Money tied up in a stale position is not sunk, it is simply deployed. The right comparison is the expected return of the current position versus the next-best alternative. Holding a zombie trade because the money is "already in there" converts an active choice into a passive loss.

4. Doubling down to average down without a fresh thesis. Adding to a loser can be rational if the new price genuinely improves forward expected value. It is irrational if the only reason is that the original purchase price now looks attractive relative to the higher one.

5. Treating sweat equity as sunk cost in your favour. Research hours, watchlist attention, and emotional investment are also unrecoverable. They do not earn a position any special treatment either.

Frequently Asked Questions

What is the sunk cost fallacy in simple terms? The sunk cost fallacy is letting money you have already lost influence what you do with money you still have. In markets it sounds like "I cannot sell now, I have already lost too much." The correct question is whether the remaining capital has a better home, independent of what you paid.

How does the sunk cost fallacy affect investment decisions? It keeps investors in positions past the point where the forward case justifies ownership. Arkes and Blumer's 1985 research showed people systematically continue failing projects and hold purchased items longer when more was paid for them, a pattern that maps directly onto holding a deteriorating position.

What is a real-world example of the sunk cost fallacy? You bought a stock at 50. The thesis has broken: guidance was cut, a product launch failed. The stock trades at 30. Rational analysis says redeploy the remaining capital. Sunk-cost reasoning says "I cannot sell with a 20-point loss", treating the unrecoverable loss as a reason to stay, rather than ignoring it and asking where the remaining 30 goes next.

How can investors avoid the sunk cost fallacy? Apply the reframe every time you are tempted to hold: if I had this cash today instead of this position, would I buy it at the current price? If not, the only reason to hold is the sunk cost, and that is not a valid reason. Also separate transaction costs, real, forward costs, from purchase price, which is sunk and irrelevant to the forward decision.

How is the sunk cost fallacy different from a legitimate reason to hold? A legitimate hold is based on the forward case: the thesis is intact, the position is sized correctly relative to current risk, and the expected return still clears your hurdle. The sunk cost fallacy is holding because of what you paid, not because of what the position offers from here. If the only reason you can articulate for holding is your purchase price, that is the fallacy.

Sources

1. Arkes, H. R., & Blumer, C. (1985). "The Psychology of Sunk Cost." Organizational Behavior and Human Decision Processes, 35(1), 124-140. https://www.sciencedirect.com/science/article/abs/pii/0749597885900494
2. BehavioralEconomics.com. "Sunk Cost Fallacy." Mini-encyclopedia of Behavioral Economics. https://www.behavioraleconomics.com/resources/mini-encyclopedia-of-be/sunk-cost-fallacy/
3. CFA Institute. "The Behavioral Biases of Individuals." Refresher Readings. https://www.cfainstitute.org/insights/professional-learning/refresher-readings/2026/the-behavioral-biases-of-individuals
4. "Loss Aversion as a Potential Factor in the Sunk-Cost Fallacy." PubMed Central. https://pmc.ncbi.nlm.nih.gov/articles/PMC7318389/

Disclaimer

This article is educational content only and is not financial advice. Nothing here is a recommendation to buy, sell, or hold any security. Consult a licensed advisor before making investment decisions.