Sunk cost is an interesting concept to think about and can actually be applied to many areas of life. It economic terms, it’s a past cost that has already been lost and can’t be recovered. In investing, people (including me!) often make mistakes, but the true mistake is letting emotions get involved and not being able to handle sunk costs well.
For example. I bought 10 shares of XYZ company at $100 on an insider tip from a friend. I paid way too much for that company and bought when the stock had a P/E ratio of 50, because my friend told me about this competitive advantage and that it was a sure thing. Except the competitive advantage my friend told me about didn’t pan out and now the company stock price is down to $10.
I now have 2 choices. I can sell the stock and lose $900. That’s my sunk cost, which I’ll never get back. Or, I can hold onto the stock and hope that the stock price recovers and in effect, try to recover those sunk costs.
When making the decision, if I deal with my emotions perfectly, I actually shouldn’t consider the sunk costs and just look at whether or not I actually want to hold that company at $10/share. It doesn’t matter that I bought it at $100 because it’s already a sunk cost. If the stock looks good at $10, hold onto it. If not, sell and take the loss and invest that $100 in something that looks better now.