Bag Holder

A bag holder is a term that people use to describe an investor who holds instead of selling a financial asset that decreases in value until it becomes worthless. For individuals, it is crucial to avoid financial instruments that are bag-holding candidates to prevent significant losses.

Typically, such an investor holds on to a poorly-performing investment hoping for a turnaround, or they are unwilling to cut their losses and sell the security. Individuals must control their biases and steer clear of value traps to avoid becoming bag holders. Over time, the term has become a popular jargon among retail investors.

Key Takeaways                                                               

• Bag holder in investing refers to a person who invests in a poorly-performing financial asset and holds on to it until it has no value left. They hope that the stock price will rebound, ignoring the sell signals.
• Individuals can become bag holders if they do not want to accept that they purchased the wrong security.
• Usually, bag-holding candidates have certain features, such as decreasing market share, deteriorating economic moat, an inefficient management team, and a flawed business model.
• One could end up bag-holding if they do not monitor their portfolio performance and remove the underperforming financial assets.

Bag holder meaning implies investors who hold a poorly-performing financial asset for a prolonged period during which the investment’s time value becomes zero. Such persons decide not to offload their holdings and incur losses hoping the price will surge again. During the holding period, they ignore all the signs that suggest they should sell the security. This may happen because of multiple reasons like inexperience, emotion, and behavioral bias.

The term originated during the Great Depression when individuals stood in queues of soup kitchens and breadlines holding potato-filled bags. That said, now it has become quite popular in the investment world.

Value investors who seek underpriced stocks run a high risk of becoming bag holders. They buy stocks that are out of favor in the market, believing their price will rebound. This means that they even invest in stocks that have declined in value significantly. In such cases, there’s always a chance that the market may know more than them, and the security price drops further.

Various inexperienced investors recently ended up bag-holding owing to the meme stock frenzy. Instead of relying on thorough research and analysis, they purchased securities based on social media hype without a proper exit strategy. As a result, they ended up holding the stocks with almost no value remaining.

Once individuals understand bag holder meaning, they must know why investors may choose to hold a security until there is no value left. So, let us take a look at them.

• When investors do not monitor their portfolio’s performance, they fail to eliminate the security that is performing poorly. As a result, they may hold a financial asset until it is completely worthless.
• Many individuals become bag holders in investing because they do not wish to acknowledge that they made a wrong decision and incur losses. They are unwilling to lose money and want to sell the security when they can break even or realize gains. Experts in behavioral finance refer to this conduct as the disposition effect. It refers to investors' tendency to stay invested in underperforming securities for a prolonged period while exiting profitable trades prematurely. 

Generally, securities can be bag-holding candidates if they have the following features:

• Suspicious accounting practices
• Deteriorating financial position
• Flawed business model
• An inefficient management team
• Decreasing market share
• Deteriorating economic moat
• A significant jump in value owing to social media hype only
• Deteriorating fundamentals, etc.

Investors must conduct thorough research and analysis before investing in securities to avoid bag-holding candidates. In other words, they must assess the company’s fundamentals, competitive landscape, and prospects.

One must understand the difference between bag holding and volatility in the securities market. In the case of the former, an investor holds a financial instrument for a prolonged duration, and during that period, the security’s value falls significantly, and it descends into worthlessness. This is not the same for any investor who witnesses their holdings decline in value only to see the price rise again.

Consider an individual who purchased Apple stock in late March 2022 when the shares traded around the $178 mark. In three months, the stock price plunged to the $130 level, thus losing more than 25% of its value. However, the share price surged to an intraday high of $175 within two months. This is an example of volatility in the stock market, not bag-holding. Such price fluctuations are entirely normal in the equity market.

John purchased shares of XYZ company when the stock reached an all-time high of $57 after three years from the date of its IPO. Shortly after, the key management team members left the organization, and the company made the headlines for dubious accounting practices. Over the next year, the company’s share price plummeted. John ignored the sell signals hoping the company would bounce back, but a turnaround did not materialize. With the stock trading around $1 per share, John has become a bag holder.