Sunk Cost Fallacy

The Story

Sarah bought shares in a UK high-street retailer for £4,200. Over two years, the share price dropped by half. Friends suggested she sell and reinvest, but Sarah kept saying, "I've already put so much in — I can't sell now. I'd be locking in a loss."

So she held on. And on. The company eventually went into administration, and Sarah lost everything. The money she'd originally invested was gone long before she admitted it. She wasn't making a rational decision about the future — she was anchored to the past.

What Is the Sunk Cost Fallacy?

The sunk cost fallacy is our tendency to continue investing time, money, or effort into something because of what we've already spent, rather than evaluating the future prospects on their own merits. The money is gone either way — that's what "sunk" means — but we struggle to accept it.

It's the same reason you sit through a terrible film because you paid £12 for the ticket, or keep eating a disappointing restaurant meal because it cost £30. The rational move is to cut your losses, but it feels like waste.

Sunk Cost Fallacy in Finance

This fallacy is devastatingly common in investing. A study by Arkes and Blumer (1985) first demonstrated how powerfully sunk costs influence decisions, and decades of research since have confirmed it operates strongly in financial contexts.

In the UK, the sunk cost fallacy shows up everywhere. Homeowners pour thousands into renovating a property that would be better sold. Investors cling to underperforming funds because they've paid years of management fees. People stay in expensive gym memberships they never use because they've "already committed."

One particularly British version: endowment mortgages. Thousands of homeowners in the late 1990s and 2000s were advised their endowment policies wouldn't cover their mortgage. Many kept paying into them anyway — because they'd already paid in for years — rather than switching to a repayment mortgage. The sunk costs kept them trapped in a bad product.

"Sunk costs are like spilt milk — no amount of crying changes the situation, but we cry anyway." Thaler (1980) first connected sunk cost behaviour to mental accounting, showing that people treat past expenditures as investments requiring future justification, even when the rational response is to ignore them entirely.

How to Protect Yourself

Ask the fresh-start question. For any investment you hold, ask: "If I had this money in cash today, would I buy this?" If the answer is no, the only reason you're holding is sunk costs.

Set exit rules in advance. Before investing, decide under what conditions you'll sell. Write it down. A stop-loss rule — "I'll sell if it drops 20% from my purchase price" — removes emotion from the decision.

Reframe losses as tuition. Every investor makes bad picks. Treat losses as the cost of learning, not as debts that need recovering from the same investment.

Review your portfolio with fresh eyes. Once a year, look at every holding and ask whether you'd buy it today at its current price. If not, consider selling and redeploying that capital.

Beware of "averaging down." Buying more of a falling share to reduce your average cost per share feels clever, but it's often the sunk cost fallacy wearing a disguise. Only add to a position if the investment thesis is genuinely stronger, not just cheaper.

Reflection Questions

• Are you holding any investments primarily because you've already lost money on them?
• Have you ever stayed with a financial product — an insurance policy, a savings account, a subscription — simply because you'd already paid into it for years?
• What would you do differently if you could start your portfolio from scratch today?

Research Note

Key references: Arkes, H.R. and Blumer, C. (1985) "The Psychology of Sunk Cost," Organizational Behavior and Human Decision Processes, 35(1), pp. 124-140. Thaler, R.H. (1980) "Toward a Positive Theory of Consumer Choice," Journal of Economic Behavior & Organization, 1(1), pp. 39-60.