Sunk Cost Fallacy: Why You Can't Let Go of Bad Investments
You have held a stock for three years, and it is down 60%. You keep holding because "I have already lost so much, I might as well wait for it to come back." The money you have already lost is gone. The only question that matters is: will it go up from here? Sunk costs should not affect future decisions — but they do.
The sunk cost fallacy is the tendency to continue investing in a losing proposition because of the time, money, or effort already invested, even when continuing represents an irrational use of resources. The concept is straightforward in economics: sunk costs are past costs that cannot be recovered and should not influence current decisions. But humans are not rational economic actors. Research by Hal Arkes and Catherine Blumer showed that people are far more likely to continue a project when they have already invested significant resources, regardless of the project's future prospects. The fallacy is driven by the desire to avoid waste and the inability to accept that past investments are gone — the pain of "wasting" the past investment feels worse than the pain of continuing to invest in a losing cause.
The Concorde fallacy — named after the British-French supersonic jet that continued to receive government funding long after it was clear it would never be commercially viable — perfectly illustrates sunk cost thinking. Governments poured billions into the Concorde because they had already poured billions in, even though every new dollar was guaranteed to produce no positive return. In investing, the pattern is identical: an investor buys a stock at $100. It falls to $70. They buy more, "averaging down." It falls to $50. They buy more. Each purchase is rationalized by the past investment: "I have already lost so much, I need the stock to recover to break even." But the stock does not know what you paid. It does not owe you a recovery. Each new dollar invested should be evaluated entirely on its own merits at its own entry price — not on the performance of past dollars. Averaging down into a declining position is doubling down on a mistake, not correcting it.
Why Sunk Cost Fallacy Persists
The sunk cost fallacy persists because of three psychological forces. First, loss aversion makes the thought of realizing a loss unbearably painful, so investors avoid it by continuing to hold. Second, commitment bias (also called escalation of commitment) causes people to remain consistent with their past decisions — admitting a stock purchase was a mistake threatens the investor's self-image as a competent decision-maker. Third, the desire to avoid waste makes selling feel like "wasting" the money already lost, as if holding keeps the possibility of recovery alive. These forces combine to create a powerful trap: the more you lose, the harder it becomes to walk away, because walking away would mean accepting that all your past investment was for nothing. This is exactly backward — every dollar kept in a losing position that should be sold is a dollar that could be deployed in a better opportunity, and the best time to walk away was yesterday. The second-best time is today.
Real-world examples of the sunk cost fallacy in investing are everywhere. In the crypto bear market of 2022-2023, many investors continued buying more Bitcoin and Ethereum as prices fell, not because their analysis suggested fair value was higher, but because they had already lost so much and needed the price to recover to break even. Some held tokens from projects that had clearly failed — development had stopped, the team had left, the technology was obsolete — yet they could not sell because of the sunk costs. In the stock market, investors in companies like Blockbuster, Kodak, and Sears held on long after the business models were clearly obsolete, because they had owned the stocks for years and could not bring themselves to admit the thesis had broken. The sunk cost fallacy is the primary reason that long-term holding periods often correlate with poor returns — it is not that long-term investing is bad, but that investors use "long-term" as a justification for failing to sell broken positions.
How to Overcome the Sunk Cost Fallacy
The most effective strategy is to implement a strict pre-commitment rule: determine your exit criteria before entering any position and execute them mechanically. Set a stop-loss at 15-20% below purchase price and never waive it. When a position is down, ask the forward-looking question: "If I had $X in cash today (the current value of my position), would I use it to buy this stock at the current price?" If no, sell. Do not consider your purchase price, how long you have held, or how much you have lost — those are all irrelevant. Use tax-loss harvesting to turn the pain of selling into a financial benefit. Harvest losses to offset gains and reduce your tax bill, which reframes selling losers from "admitting defeat" to "strategic tax management." Finally, recognize that the money already lost is gone. It does not belong to you anymore. The only question is whether your remaining capital will earn a better return in this investment or elsewhere. Usually, the answer is elsewhere.
FAQs
What is the sunk cost fallacy in investing?
The sunk cost fallacy in investing is the tendency to continue holding or adding to a losing investment because you have already invested money, time, or emotional energy into it. The fallacy is that past costs should not influence future decisions — the only relevant factors are the current price and the expected future return. Yet investors regularly throw good money after bad because they cannot accept that their initial investment was a mistake. The cure is to ignore your purchase price and ask the forward-looking question: would I buy this today at the current price with fresh money?
How is averaging down related to the sunk cost fallacy?
Averaging down — buying more of a stock as it falls — is often driven by the sunk cost fallacy. The investor's reasoning is typically: "I bought at $100, now it is $50, so if I buy more at $50, my average cost will be $75, making it easier to reach breakeven." This logic ignores the key question: why did the stock fall 50%? If the original thesis is still intact, averaging down can be rational. If the thesis has broken — the company's competitive advantage has eroded, earnings have collapsed, or the industry has changed — averaging down is doubling down on a mistake. The sunk cost fallacy makes investors average down without honestly reassessing the thesis, turning small losses into catastrophic ones.
Can the sunk cost fallacy ever be rational?
In theory, the sunk cost fallacy should never affect rational decisions — by definition, sunk costs cannot be recovered and should be ignored. However, there are situations where continuing a losing investment might be rational for reasons unrelated to the sunk cost. For example, a business might continue a failing project because abandoning it would damage customer relationships or reputation, creating larger losses elsewhere. Or an investor might hold a losing stock because selling would trigger a large taxable gain (from other positions). In these cases, the decision to hold is based on forward-looking considerations, not on the past investment. The key test is: if the past investment were wiped from your memory, would you still make the same decision today? If yes, the decision is rational. If the only reason to hold is "I have already lost so much," it is the sunk cost fallacy.