Sunk Cost Fallacy

A sunk cost is money already spent that no decision can recover: the purchase price of a share that has fallen, the renovation already poured in, the fees already paid. The sunk cost fallacy is treating that money as a reason to continue - holding the loser to 'get back to even', spending more to justify the first lot. The rational question is forward-looking only: knowing what I know now, would I buy this today at today's price?

In Australia the fallacy runs through the share portfolio, the investment property and the fixed-rate mortgage. A realised capital loss is not only a psychological reset. It is worth up to 32 cents in the dollar of tax offset at a 32 percent marginal rate, because capital losses reduce assessable income. The ATO's view and the behavioural view point the same direction for once. The loss has value when it is realised and none while it is held and hoped over.

The mechanics run through the decision point. A position bought at $50 that now trades at $30 carries $20,000 of decline on a $50,000 parcel, and every option is priced from the $30: hold, sell or add. The $50 is gone regardless of what happens next, which is why it is not an input to the decision. The only question with a forward answer is whether $30 of that company today is a good use of $30.

The tax arithmetic is the part the hope ignores. Realising the $20,000 loss at a 32 percent marginal rate saves $6,400 of tax, because capital losses offset assessable income - and the offset pairs against full-rate gains first, per the ordering rule. The realised cash can be redeployed at today's prices, which is the forward decision the fallacy postpones. The tax-loss harvesting entry covers the wash-sale rules that constrain the repurchase.

The mortgage version has a twist: the break cost on a fixed loan is not a sunk cost, it is a real forward price. Staying in a 6.5 percent fixed loan because the $17,000 break cost stung is the fallacy running in reverse - the comparison is between the break cost and the interest saved by leaving, not between the break cost and nothing. The mortgage break costs entry covers the bank's economic-loss calculation that sets the price.

For an Australian reader, the fallacy is the reason losing positions are held for years and renovations are added to rentals that will not repay them. Every month of holding costs money - interest, rates, insurance, the opportunity cost of the cash tied up - and the hope of getting back to even pays none of it. The fallacy also keeps bad fund choices and bad loans alive past the point where the forward maths has decided. The opportunity cost entry covers the counterfactual the fallacy never runs.

A colleague named Brent (yes, that Brent) held a small-cap position for four years waiting to get back to even. The $8,000 remaining was worth exactly $8,000 of decision, and the four years of hope cost roughly $2,000 of dividends, offsets and attention. The highest-leverage thing most Australians can do is run every holding through the 'would I buy it today' test once a year, and let the tax loss work when the answer is no. The tax-loss harvesting calculator prices the offset on any realised loss.