Sunk Cost Fallacy

What is the Sunk Cost Fallacy?

The sunk cost fallacy is the cognitive error of letting unrecoverable past costs influence current forward-looking decisions. Economically, sunk costs should be ignored entirely — only marginal future cash flows matter. Behaviourally, humans over-weight them because abandoning a project feels like "wasting" the past investment.

The Underlying Mechanism

Sunk cost fallacy is the bridge between loss aversion and prospect theory: abandoning a losing investment forces you to realize the loss (move from a "paper loss" to a "booked loss"), and the convex-loss segment of the value function makes this acutely painful — even when the cold rational calculus says cut and run.

Worked Indian Investing Examples

• Holding a structurally broken stock: You bought a telecom stock at Rs 800; sector economics collapsed; it now trades at Rs 200. Holding because "I'm down 75%" is the fallacy. The right question: "If I had Rs 200 cash today, would I buy this stock?" If no — sell.
• Mis-sold endowment plan: You've paid Rs 50K x 4 years into a 5% IRR endowment. Continuing for 16 more years because "I've already paid Rs 2 lakh" is the fallacy. Check surrender value, deploy proceeds in index funds + term insurance.
• SIP loyalty: A laggard equity fund underperforming benchmark for 5 years — continuing because "I've SIP-ed Rs 6 lakh into it" instead of switching to a better fund.
• The Concorde Effect: The classic non-finance example — the Anglo-French Concorde program was continued for years past its economic viability point because of the political and financial commitment already made.

The Mental Override

Replace the question "How much have I already invested?" with "Given today's information and prices, is this still the best use of every additional rupee or hour I will spend on it?" Past costs are sunk — they will be sunk whether you continue or quit.

When to Apply

• Reviewing underperforming positions in your portfolio annually
• Evaluating mis-sold insurance policies (par endowments, ULIPs from year 2010)
• Deciding whether to continue or kill a side-business with mounting losses
• Walking out of a bad movie or restaurant — even small daily practice helps

Educational only — not advice. ARN-314872.