What is a ‘Bag Holder’?
An informal term used to describe an investor who holds a position in a security which decreases in value until it is worthless. In most cases, the bag holder will hold the position for an extended period during which most of the investment is lost.
BREAKING DOWN ‘Bag Holder’
A bag holder refers to an investor that is symbolically holding a “bag of stock” that has become worthless over time.
Example of a Bag Holder
Suppose that an investor purchases 100 shares of a newly public tech start-up. While the share price briefly rises during the initial public offering (IPO), it quickly drops as analysts begin to question the business model. The subsequent earnings results show that the business model is struggling, and the stock price continues to fall. The investor that chooses to ignore the deteriorating indicators and continue to hold the stock is a bag holder.
There are several reasons why an investor may hold on to a security as it becomes worthless. For example, an investor may simply neglect his or her portfolio or hold on to a stock because they are unwilling to admit that they were wrong about the premise for a trade.
The disposition effect is the tendency among investors to sell shares in a security whose price has increased while keeping securities that have dropped in value. In other words, investors tend to hold on to losing positions longer than winning positions. Investors tend to dislike incurring losses much more than they enjoy making gains, which causes them to gamble on the idea that losing positions will turn around and prematurely lock in profits for winning positions.
An example of this effect and its underlying causes is illustrated by prospect theory. In general, people would much rather receive $50 than have $100 and lose $50 even though the end result in both cases is $50. Other examples of this effect are individuals who prefer not to deposit money in banks even though it would earn interest or individuals who choose not to work overtime because they may incur higher taxes.
Sunk Cost Fallacy
The sunk cost fallacy is another reason that an investor may become a bag holder.
Sunk costs are costs that have already been occurred and cannot (or are unlikely to be) recovered. For example, suppose that an investor purchased 100 shares of stock for $10 in a transaction valued at $1,000. If the stock falls to $5 per share, the market value is just $500. The $500 lost is a sunk cost at that point in time. Many investors are tempted to wait until the stock goes back up to $1,000 to recoup their investment, but the losses have already become a sunk cost.
Many investors hold on to a stock for too long because it’s an unrealized loss, which means that it’s not reflected in their actual accounting until the sale is complete. In some cases, this encourages investors to perceive an opportunity for prices to recover.
The Bottom Line
Bag holder is an informal term used to describe an investor who holds a position in a security which decreases in value until it is worthless. Bag holders often succumb to the disposition effect or sunk cost fallacy, which causes them to hold on to a position for too long.