Sunk cost fallacy explained for investors

You buy a movie ticket, the film is boring, but you stay till the end because you paid for it. That is the sunk cost fallacy in daily life. This page explains how the same habit shows up in investing and how to avoid it.

Quick answer

The sunk cost fallacy is the habit of continuing with a decision because of money, time or effort already spent, even when continuing no longer makes sense. A sunk cost is money that is gone and cannot be recovered. In investing, it can lead people to hold or even add to losing positions just to 'justify' what they already put in.

Key takeaways

• A sunk cost is money already spent that cannot be recovered.
• The sunk cost fallacy lets past spending drive future choices.
• It can lead to holding or averaging down losers.
• Good decisions look only at future costs and benefits.
• Clear exit rules help avoid this trap.

What is the sunk cost fallacy?

A sunk cost is a cost that has already been paid and cannot be taken back. Since it is gone either way, it should not affect what you do next. Logically, only future costs and benefits matter.

The fallacy happens when people let these past costs guide their choices. They continue something because they have 'already invested so much', even though stopping might be the better option.

Examples in investing

An investor buys a share at Rs 800. It falls to Rs 400 after the company reports weak results. Instead of asking whether the business is still sound, the investor keeps holding because selling would 'waste' the money already lost.

Some go further and buy more to lower their average cost, without new reasons to believe in the company. Averaging down can make sense when the original case is still strong, but doing it only to protect a past decision is the sunk cost fallacy at work.

Why do people fall for it?

Loss aversion is a big reason. Selling makes a loss real, and that hurts. People also dislike admitting mistakes, so continuing feels better than accepting that a choice did not work.

The fallacy also connects to the disposition effect, where investors hold losers too long. Both habits put the past ahead of a clear look at the present.

How to avoid the sunk cost fallacy

Focus only on the future. For each holding, ask what you expect from here, based on current facts like results, debt and valuation. The price you paid should not be part of that answer.

Set rules before you invest, such as a stop loss or a clear list of reasons that would make you exit. Following a written trading plan makes it easier to act on facts instead of feelings about the past.

The key point to remember

Money already lost is gone whatever you do next. The sunk cost fallacy turns that past loss into a reason for more poor choices. Looking forward, not back, is the simple fix.

Frequently Asked Questions