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Sunk cost

A sunk cost is any expense that cannot be recovered.

Expanded Definition

Sunk costs are those which, once paid, can't be refunded or recovered.

For example, money spent in research and development is typically a sunk cost, since the money spent on salaries and supplies can't be recovered even if that research doesn't result in a saleable product. Similarly, if you spend $5 on a lottery ticket, you can't return it for a refund if you change your mind or if you don't win.

The concept of the sunk cost doesn't only apply to money -- it can apply to anything of value, including time and effort.

According to classical economic theory, a rational actor doesn't take sunk costs into account -- choices depend only on their own merits. However, more recent economic research reveals that people do make decisions on the basis of sunk costs through what's known as the sunk cost fallacy.

The sunk cost fallacy describes our inherent aversion to loss. It manifests in a tendency to assume that if we've already spent resources on something, we should continue to spend resources on it even if we would otherwise prefer to do something else. For example, we might hold on to possessions we have no use for instead of donating them to a charitable organization because getting rid of them would imply that we had wasted the money we spent to buy them.

In investing, the sunk cost fallacy is most commonly seen in the tendency of investors to hold on to stocks on which they have lost money and which they no longer believe in simply because they don't want to have "wasted" the original investment.

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