What is a sunk cost?

A sunk cost refers to a cost that has already been incurred and cannot be recovered. This concept is crucial for decision-making in personal finance and business because it emphasizes that past expenses should not influence current and future decisions. When evaluating projects or investments, individuals and businesses must focus on potential future benefits and costs rather than allowing previous expenditures—such as funds spent on a failed initiative—to sway their choices.

Understanding sunk costs aids in making rational decisions by encouraging one to disregard these unrecoverable costs and concentrate on the values and benefits that prospective options can provide. This principle is often discussed in the context of evaluating whether to continue a project or to cut losses, reinforcing that resources should be allocated based on future potential rather than past expenditures.

Other options do not accurately reflect the definition of a sunk cost. For example, a recoverable cost would not qualify as a sunk cost, as it implies that it could be returned or recouped in some way. Similarly, future costs associated with a potential investment or costs related to purchasing new assets do not fit the definition of sunk costs, as they pertain to anticipated spending rather than irreversible costs already incurred.