What are sunk costs?

Sunk costs refer to money that has already been spent and cannot be recovered. This concept is essential in decision-making because it emphasizes the importance of disregarding these past expenses when evaluating the viability of future actions. When making decisions, individuals and businesses should focus on potential future costs and benefits, not on what has already been invested, as those sunk costs do not influence the outcome of future decisions.

In practical terms, recognizing sunk costs helps prevent the "sunk cost fallacy," where individuals continue to invest resources into a project simply because they have already incurred significant expenditures, even when it may no longer be rational to do so. This understanding fosters better financial decisions and encourages a more forward-thinking approach in evaluating investments and projects.