They keep it for one reason: they’ve lost money on it. Not because they believe in the company. Not because it fits the rest of the portfolio. Not because the fundamentals have changed for the better. Just because selling now would mean admitting the loss — and as long as they hold on, the loss still feels reversible.
That feeling is one of the most expensive emotions in investing. It has a name: the sunk cost fallacy.
What sunk cost actually means
The sunk cost fallacy isn’t unique to investing. It shows up everywhere humans make decisions.
You stay through a bad movie because you already paid for the ticket. You finish a meal you don’t like because you ordered it. You keep pouring time into a project that’s no longer working because of how much you’ve already put in. In every case, the past cost — money, time, effort — is gone regardless of what you do next. It can’t be recovered by continuing.
But it doesn’t feel gone. It feels like quitting now would make the loss real, and continuing might still let you recover it. That feeling is wrong, but it’s powerful.
Why investors are especially vulnerable to it
In portfolios, sunk cost thinking gets supercharged by two other psychological forces.
The first is loss aversion — the well-documented finding that losses hurt about twice as much as equivalent gains feel good. A 30% loss isn’t just unpleasant; it’s psychologically severe enough that people will take significant risks to avoid realizing it. As long as a losing position stays in the account, the loss is on paper. Sell it, and the loss becomes real. Most brains will do almost anything to delay that.
The second is identity. Buying a stock is, at some level, a statement: I think this is a good investment. Selling it at a loss is the closest thing to admitting you were wrong. That’s a small ego hit, and ego hits are something people work hard to avoid — even when avoiding them is expensive.
Put together, these forces create a predictable pattern: investors hold their losers far too long, and sell their winners far too early. Studies of brokerage account data have confirmed this for decades.
The right question
Here’s the test. It’s a single question, and it works for any holding in any portfolio:
If you didn’t already own this position, would you buy it today at the current price?
That’s it. That’s the whole framework.
If the answer is yes — the company is still strong, the thesis still holds, the fit in your portfolio still makes sense — then holding is the right decision. You’re not holding because of the loss; you’re holding because it’s a good investment.
If the answer is no, then the only thing keeping you in the position is the prior loss. And the prior loss is gone whether you sell or not. The question of what to do next should be made entirely on the merits of the position going forward.
The past loss is data about what already happened. It’s not data about what will happen next.
When it’s not sunk cost thinking
Worth being clear: this isn’t an argument that you should always sell losers.
There are legitimate reasons to hold a position that’s currently down — strong fundamentals temporarily out of favor, tax considerations around realized gains and losses, dividend income, the position’s role in a broader allocation, or a thesis that simply needs more time to play out.
The fallacy isn’t holding a losing position. The fallacy is holding it because of the loss — using the prior loss as the justification for the decision, instead of evaluating the position on its current merits.
If you can articulate a clear forward-looking reason to keep something, that’s a reasoned decision. If the only reason you can come up with is “I don’t want to sell at a loss,” that’s the fallacy talking.
A practical framework
Once a year, go through every position in your portfolio and ask the replacement question. For each holding:
- Yes, I’d buy it today → keep it
- No, I wouldn’t buy it today → it stays only if there’s a non-loss reason (tax timing, role in allocation, etc.)
- I don’t know → that’s its own answer. If you can’t articulate why you own something, the position is running on autopilot.
This exercise is harder than it sounds, because the brain will fight you on every losing position. But the question is the right one. The money already lost is irrelevant to the decision in front of you.
The bottom line
Just because you own it doesn’t mean you should keep it. Just because you’ve lost money on it doesn’t mean you should keep it either.
The only question that matters is whether the position is worth holding from today forward. If it is, hold it. If it isn’t, the past losses are irrelevant — and continuing to hold just to avoid realizing them is the textbook definition of throwing good money after bad.
When it’s time to move on, move on.
This article discusses general behavioral finance concepts for educational purposes and is not personalized investment advice. Decisions about specific holdings depend on individual circumstances including time horizon, tax situation, overall portfolio composition, and goals. Investing involves risk, including the possible loss of principal.
Most portfolios have at least one “sunk cost” position
The hardest part of the replacement test is doing it honestly on your own holdings. The bias to keep what you already own — especially what’s lost money — is strong, and it’s the reason most people benefit from a second set of eyes.
A portfolio review walks through every position and asks the forward-looking question for each one. It also surfaces the fees and structural costs that often make holding the wrong positions even more expensive than the original loss.
Schedule your portfolio review or reach out directly at inquiry@advisormike.com.
