Sunk Cost

What Is a Sunk Cost?

A sunk cost is an expense that has already been paid or committed and cannot be recovered, no matter what happens next. Examples include the purchase price of a stock that has since fallen, the fee paid for a research subscription, or hours spent studying a company's filings. In finance, the key idea is that sunk costs are gone. They should not influence choices about the future, because the only relevant question is what the next dollar, hour, or decision will produce from this point on.

Why Sunk Costs Matter to Investors

Many investors find it hard to ignore sunk costs. Someone who bought a stock at $80 and sees it trade at $50 may feel reluctant to sell, because selling would make the loss feel real. Yet the $80 purchase price is irrelevant to whether the shares are likely to rise or fall from $50. A decision based on "I need to get back to what I paid" is an example of letting a past cost shape a present choice.

This tendency is closely tied to the disposition effect, a documented pattern in which investors tend to sell winning positions too early and hold losing positions too long. It is also related to loss aversion, the idea that losses tend to feel more painful than equivalent gains feel pleasant.

How to Think About Sunk Costs

A useful test is to ask whether a choice would look different if the past spending had never happened. If you would still buy, hold, or sell the investment after considering only its current price and future prospects, the sunk cost is not distorting your thinking. Costs that can still be recovered, such as a transaction cost that a different action could avoid, are not sunk and may belong in the decision.

Sunk cost reasoning is not always wrong in practice, since past information can be useful evidence about a company. The problem arises when the past spending itself becomes the reason for a decision.