Why does the ‘hold’ rating exist in securities research?
Is it rational?
Think about it, if a security is not worth buying today, why is it worth holding?

The whole construct of having a “hold” rating is to hide from us the fact that we are being irrational by putting a covert premium on something precisely because we are already holding it.

This irrationality arises out of something called the Endowment Effect or the Endowment Bias.

Anything that belongs to us automatically has higher value for us. Holds true of even a mundane coffee mug.

In an experiment, half the students were given coffee mugs and later the other half were allowed to bid for them. Whereas the potential buyers wanted to buy them for $3, the sellers who owned them didn't want to sell below $7!

When we get attached to everyday objects like coffee mugs, securities or other investments we hold are much closer to our hearts because firstly, they are more closely aligned with our well-being.

Secondly, investing in a stock or other asset means that you have analysed the options and made a conscious choice. Now you don't want to change your mind because you do not want to think that your earlier choice was incorrect.

Hence, you are likely to be even more invested mentally (pun intended) in a stock that you own than in other objects.

That's why most people will keep defending the stocks that are in their portfolio and hold on to them for too long.

In fact, the Endowment Bias is the single reason why a “Hold” rating exists in the lexicon of market analysts.

Don't Kid Yourself!

You may even kid yourself that you are holding on to this investment because you do not want to incur unnecessary transaction costs but the fact is often that investment may not make sense even if you net out the transaction cost involved.

Usually the transaction cost of a switch in investments is negligible compared to the potential loss of holding onto the wrong investment or the potential profit forgone for not making a switch to the right asset.

Other factors involved may be just a comfort factor with something familiar or a decision paralysis that leaves your portfolio unchanged for long periods because you want an irrational premium to sell something you hold.

The problem is such rationalisations can be detrimental to your financial health because of the failure to take the required action.

Since you now know that this is a cognitive bias, you need to guard yourself against it. The only real way to make a start is a zero-base portfolio approach.

Do not think that how can I sell Hindustan Unilever shares bought by my parents or that I have made a ton of money on HDFC Bank or Apple, so I should continue to hold them.

The only rational way to do this is to think and decide that if I had everything in cash today how would I deploy it. Do this at least once and twice a year. Preferably with another set of eyes as well.

From the desk of Devina Mehra

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