Sunk Costs are Irrelevant

So why did I title my blog “Sunk Costs are Irrelevant”? Well, let’s start with sunk costs. Sunk costs is a term primarily used in accounting. It refers to costs “that have been incurred and which cannot be recovered to any significant degree.” Thus, one seeking to make a rational decision would not consider any of these costs going forward for this asset. This is more easily understood through an example.

Let’s say you buy some stock in a non-dividend paying company called Defeatist United Machines (Ticker: DUM), it goes down 20% the next day, and it announces that earnings for the next 3 years will be below expectations. Would you hold onto the stock? Many would despite the news that it will likely underperform for the foreseeable future. This would be loss aversion or a sunk cost fallacy.

Another application beyond the area of finance is best illustrated by an interaction between Robert DeNiro and Al Pacino in the movie Heat.

Deniro as Neil McCauley: “A guy told me one time, don’t let yourself get attached to anything you are not willing to walk out on in 30 seconds flat if you feel the heat around the corner.”