Sunk Cost Fallacy Investing: 6 Ways It Quietly Drains Your Portfolio
Sunk cost fallacy investing mistakes cost real money: in one landmark study of 10,000 brokerage accounts, investors sold 14.8% of their winning positions but only 9.8% of their losing ones, which means they kept the stocks that were hurting them. This guide explains how the sunk cost fallacy shows up in a portfolio, which six habits give it away, and a simple forward-looking test you can use to decide whether to hold or sell.
What the Sunk Cost Fallacy Investing Trap Actually Looks Like
A sunk cost is money (or time, or effort) you have already spent and cannot get back. The fallacy is letting that spent amount steer a decision that should only depend on what happens next. In an investment account, the sunk cost is almost always your purchase price. The market does not know what you paid. A stock bought at $80 that now trades at $50 has the same future prospects for you as for a stranger who buys it today at $50.
Yet most of us feel the difference sharply. Selling feels like “making the loss real,” so we wait to “get back to even.” That phrase, get back to even, is the tell. It anchors the decision to a price in the past rather than to the expected return from here. If you have noticed the same pull when you decide whether to keep a dormant subscription, our subscription audit checklist built on a cost-per-use formula shows the same logic applied to a smaller, safer place to practice.
Three ingredients make the trap especially sticky with investments: a visible reference price (your cost basis is on every statement), a story you told yourself when you bought, and the fact that an unrealized loss can be postponed indefinitely. Nothing forces the decision, so the fallacy quietly wins by default.
The Research: Theater Tickets, Gym Memberships, and Losing Stocks
The behavior is well documented, and the studies are worth knowing because they show it is not a character flaw. It is the default setting of human decision-making.
- Theater season tickets. In a 1985 paper, Hal Arkes and Catherine Blumer randomly gave theater-goers different ticket prices. Those who paid full price attended more plays during the first half of the season than those who got a discount, even though the enjoyment of the plays was identical.
- Gym memberships. Economists Stefano DellaVigna and Ulrike Malmendier studied health club contracts and found that members on monthly plans paid an average of about $17 per visit, while a 10-visit pass would have cost roughly $10 per visit. Many kept paying for access they rarely used.
- Brokerage accounts. Terrance Odean’s 1998 Journal of Finance study found investors realized 14.8% of their paper gains but only 9.8% of their paper losses. This pattern is called the disposition effect, and sunk cost thinking is one of its engines.
The common thread: money already spent bends behavior going forward, even when logic says it shouldn’t. If you want the related idea that we cling to what we already own, see our piece on the endowment effect and why your stuff feels worth more.
Six Places Sunk Cost Fallacy Investing Errors Hide in Your Portfolio
Most people picture one dramatic scenario, a stock that crashed. In practice the fallacy shows up in quieter forms. Here are six, with the “tell” for each and the forward-looking question that cuts through it.
| Where it hides | What you tell yourself | Better question |
|---|---|---|
| The underwater single stock | “I’ll sell when it gets back to what I paid.” | Would I buy it today at this price? |
| The expensive actively managed fund | “I’ve held it for ten years already.” | What are the fees and expected return from here? |
| Averaging down on a falling stock | “Buying more lowers my average cost.” | Is this the best use of the next dollar? |
| The inherited or gifted position | “It was important to the person who gave it.” | Does it fit my plan, apart from the history? |
| The strategy you spent months learning | “I put too much time into this to quit.” | Has it beaten a plain index fund after costs? |
| The paid-for tool or newsletter | “I already paid for the year.” | Would I pay for it again at renewal? |
Averaging down deserves a special warning. Adding to a position because it is cheaper can be a perfectly rational rebalancing move when the original thesis is intact and the holding is a small part of your portfolio. It becomes sunk cost thinking when the real motive is to lower the number you have to “get back to.” The same quiet pull toward inaction appears in our case study on paying for doing nothing, and it is worth reading alongside this one because the two biases reinforce each other.
The Forward-Looking Test for Any Holding
The cleanest fix for sunk cost fallacy investing errors that I know is a single question: “If I held cash instead of this position today, would I buy it at the current price, in this amount?” If the answer is yes, keep it. If the answer is no, you are holding it for reasons that have nothing to do with its future, and that is the sunk cost talking.
Here is how the test sorts a handful of common situations.
| Situation | Cost-basis thinking says | Forward-looking test says |
|---|---|---|
| Broad index fund, down 15% | Sell to stop the pain | Hold; I’d happily buy it today |
| Single stock, down 40%, thesis broken | Hold until break-even | Sell; I wouldn’t buy it now |
| Fund with a 1% expense ratio, up 20% | Hold; it’s working | Compare to a low-cost alternative |
Notice the test cuts both ways. It does not tell you to dump everything that is down. It tells you to judge each holding on what you expect from here. I started running this check on my own accounts a few years back, mostly out of curiosity about whether my index-fund-heavy approach was as boring and bias-proof as I assumed. The honest answer: mostly yes, but I found a couple of small leftover positions that I’d kept purely out of attachment to the story I told when I bought them. As a software engineer, I tend to treat decisions like code reviews: the history of a commit doesn’t matter, only whether the code should ship now.
If you want to see how quickly a consistent, low-cost approach compounds once you stop second-guessing it, try the calculator below.
What could the proceeds of a stuck position grow into if reinvested in a diversified fund?
Turning a Loss Into a Tax Asset
Here is the part that makes selling less painful: a realized loss is not just a loss. In a taxable account, the IRS lets capital losses offset capital gains, and if losses exceed gains you can deduct up to $3,000 per year ($1,500 if married filing separately) against ordinary income, carrying the rest forward to future years (IRS Topic No. 409). So holding a loser “until it comes back” can mean giving up a tax benefit today for a hope about tomorrow.
There is one rule to respect. Under the wash-sale rule, if you buy the same or a substantially identical security within 30 days before or after the sale, you cannot claim the loss. Our wash-sale rule case study walks through how people trip over it, and the math on whether it is worth the effort for a modest account is in our guide to tax-loss harvesting for small portfolios. This only applies to taxable accounts, not IRAs or 401(k)s, and I am not a tax professional, so check your situation with a qualified one.
Building Systems That Take Ego Out of the Decision
Willpower is a poor defense against a bias this emotional. Systems work better. A few that are easy to set up:
- Write the thesis down at purchase. One sentence on why you own it and what would make you sell. When the reason disappears, the decision is already made.
- Hide cost basis on your dashboard. Some brokerages let you show only current value and allocation. Looking at your plan rather than your purchase price removes the “get back to even” anchor.
- Review on a calendar, not on a feeling. A scheduled yearly review turns “should I sell?” into routine maintenance. Our look at the gambler’s fallacy in investing explains why waiting for a position to be “due” is another trap to avoid.
- Prefer broad index funds for the core. It’s hard to have a sunk cost story about a fund that owns thousands of companies.
- Decide with a friend or a checklist. Saying the forward-looking question out loud makes it harder to rationalize.
When Holding a Loser Is Actually Right
Not every hold is a mistake. If you would buy the position today at today’s price, holding is the right call regardless of what you paid. Taxes can also tilt the decision: selling a big winner could trigger a gain you would rather defer, and that is a forward-looking consideration, not a sunk cost. The point is not to sell more; it is to make sure the reasons you keep are about the future.
Key Takeaways
- Sunk cost fallacy investing errors come from treating your purchase price as relevant; it is history, and only expected future returns, costs, and taxes should drive hold-or-sell decisions.
- Research from Arkes and Blumer, DellaVigna and Malmendier, and Odean shows sunk cost thinking is common, measurable, and costly.
- Ask: “If I held cash, would I buy this at today’s price?” If not, you are holding for the wrong reason.
- In taxable accounts, realized losses can offset gains and up to $3,000 of ordinary income per year, subject to the wash-sale rule.
- Written theses, scheduled reviews, and broad index funds reduce how often the bias gets a vote.
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