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What Is A Sunk Cost?

Views 862022.06.16

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Key takeaways

  • Sunk cost refers to costs that have already been incurred and are unrecoverable.

  • Sunk costs are excluded from future decisions because the costswill be the same regardless of the outcome.

  • When making investment decisions, one should avoid adding more money into investments that are struggling to take off only because one is in fear that the initial investments were all in vain.

Understanding sunk costs

A sunk cost refers to a cost that has already occurred and cannot be recovered. 

Sunk costs are independent of any event and should not be considered when making investment or project decisions. 

Only relevant costs that relate to a specific decision and will change depending on that decision should be considered.

However, many managers continue investing in projects because of the sheer size of the amounts already invested in prior periods. They do not want to "lose the investment" by curtailing a project proven not profitable and continue pouring more cash into it.

They should regard earlier investments as sunk costs and exclude them from consideration when deciding whether to continue investments.

Economic analysis ignores sunk costs because it helps prevent decision-makers from throwing good money after bad when they are stuck in an unprofitable project.

All sunk costs are considered fixed costs. However, not all fixed costs are sunk costs, as sunk costs cannot be recovered. For example, a piece of equipment can be resold or returned at a set price. Therefore, it is a fixed cost but not a sunk cost.

Examples of the sunk cost fallacy

When making investment decisions, one should avoid adding more money into investments that are struggling to take off only because one is in fear that the initial investments were all in vain.

In the following examples, you can see how sunk costs cause people to think irrationally when making a decision.

  • Tom purchased a movie ticket online for $12.50 and found the movie boring when he sat in the theater. He decided to sit through the entire film because he had already bought the ticket.

  • Jennifer paid a $100 entry fee to join a new tutoring club. After attending four of the seven sessions, Jennifer found the tutoring sessions not helpful. Nevertheless, she decided to participate in the remaining three sessions because of the $100 entry fee.

The content in this article is intended for general circulation and informational purposes only. It does not take into account the investment objectives, financial situation or needs of any particular person and should not be relied on as advice or recommendation. Information provided in this article are not specifically intended for or specially targeted at the public in any specific jurisdiction. Neither Moomoo Inc. nor its affiliates are licensed Financial Advisers and do not provide financial advice. You are advised to consult your financial adviser before making any commitment to invest in any capital markets product. The information published is not and does not constitute or form part of any offer, invitation or solicitation to subscribe or to enter into any transaction in capital markets products. Moomoo is a professional trading app offered by Moomoo Inc. In the U.S., investment products and services on Moomoo are offered by Futu Inc., Member FINRA/SIPC. In Singapore investment products and services are offered through Futu Singapore Pte. Ltd., regulated by the Monetary Authority of Singapore (MAS). This advertisement has not been reviewed by the MAS. Moomoo Inc., Futu Inc. and Futu Singapore Pte. Ltd are affiliated companies. Any illustrations, scenarios, or specific securities referenced herein are strictly for illustrative purposes. Past investment performance does not guarantee future results. Investing involves risk and the potential to lose principal.

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