Bag Holder

DEFINITION of '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 of time in 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 shares briefly rise during the IPO, they quickly move lower as analysts begin to question the business model. The subsequent earnings results show that the business model is struggling in the public eye and the stock continues to fall. The investor that chooses to ignore the deteriorating fundamentals and continue to hold the stock is a bag holder.

Disposition Effect

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’re unwilling to admit that they were wrong about the premise for a trade.

The disposition effect is the tendency for 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. They tend to dislike incurring losses much more than enjoying making gains, which causes them to gamble that losing positions will turn around and prematurely lock in profits for winning positions.

A great example of this affect and its underlying causes in action 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 in action are people that prefer not to deposit money in banks even though it would earn interest or those that 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 those that have already been occurred and cannot (or won’t likely 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 made. In some cases, this makes investors feel that there’s 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. Often times, bag holders succumb to the disposition effect or sunk cost fallacy that causes them to hold on to a position for too long.