Sunk Costs: How Not to Invest

Gary North

There is an economic doctrine called "sunk costs." Sunk costs are costs that were made in the past. We can't do anything about the past, so those costs are sunk. As in "buried 6 feet under." They are as dead as your great- great grandmother.

If it happened in the past, face up to it. Good or bad, face up to it. You can't do anything about it, so face up to it.

If the stock market took your money away, and you want to get it back, then make your decision in terms of the most likely option available to you for getting it back.

People are stubborn. They refuse to do this. They think, "I'm going to prove I was right. I'm going to get my money back by leaving it right where it is. I will wait for this market -- my original investment strategy -- to get it back for me."

This is economically silly unless the investor really believes that leaving his investment right where it is offers him the best opportunity for recovering the losses. Yes, there may be capital gains tax implications that would create such a "hold on" situation. But in a tax-deferred retirement fund, the only economically rational question is this: "Of those options available to me in this fund, or in some fund into which I can transfer my existing funds, what is the most promising investment allocation?"

But people are paralyzed by the past. They are paralyzed by their egos. They are determined to make the money back in the same way that they lost it. They sit there. They refuse to reallocate their funds.

Sunk costs are gone. Losses sustained in the stock market are real. They are not imaginary. They don't become real only when you admit their existence by selling your remaining holdings. The losses were imposed by the fall in the market.

A person who had his money in a stock market index fund has sustained over two years of losses. He may not want to admit this to himself, but he has.

There was a retired man in my church. He told me in 2001, "I have lost a lot of money in tech stocks. If they don't go back up, my retirement plans are in trouble." What he meant was: "If I can't find a way to recoup my losses, my retirement plans are in trouble." But he didn't say that. He was assuming that he had to stay in those tech stocks, or switch to some other tech stocks, to get his retirement plans out of trouble. Then he died.

Sunk costs are sunk. This is perhaps the most difficult of all investment truths to internalize. What's past is past. Or, as my father taught me (approximately): "Don't spend time looking up a dead horse's nostrils."

So, I'm sticking with "cut your losses, and let your profits run." If an investment has gone down for a year, it's safer to sell your holdings in this market and bide your time, even in a money-market fund. The rule is: "Don't lose money."

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