When is it Ok to Average Down?

Just remember one thing…

…that the words “averaging down”…

…only go with long-term investing. 

They do NOT go with trading. 

After you have fully digested and understood the above, let’s to to the when. 

When does averaging down go with investing?

The answer to this is – only after doing proper homework. 

If you’ve not researched the underlying well enough, don’t even think about averaging down, because you could be throwing good money after bad. 

When there’s a correction, the long-term investor does get tempted to increase his or her holding, because of the lucrative prices that are on offer. 

Sure, why not?

Please understand, that this “sure, why not” is coming out so casually because of course the long-termer has worked overtime to arrive at the conclusion that he or she wishes to increase his or her stake in something that is already being held. 

The fall in the price of the underlying does not perturb the long-termer. Solid research has been done, and the markets make huge mispricing blunders when in free fall. Market players go all psycho and discard their precious holdings at throw-away prices. Picking up quality stocks at bargains is exactly what the long-termer is in it for.

The long-termer has done a few more things. 

Family has been secured with multiple income-sources and emergency funds. What’s going into the market is sheer surplus, not envisaged to be required over the next ten years. 

Then, entry quantum is small each time, small enough so that entries can be made all year round, and there will still be ample savings left after all entries. 

How does one calculate a small enough entry quantum that satisfies all of the above criteria?

One works backwards. 

Pinpoint your income after tax for the year.

Decide what you wish to amply save. Subtract this from your income. Further, subtract expenses. You are left with an amount. Decide whether all of this amount can go into the market, or whether only a part. Maybe you wish to go for a holiday with your family, or perhaps you wish to buy a vehicle, or what have you. Subtract such additional expenditure too. Finally, you are left with the amount that you wish to plough into the market, over the course of the year. 

Next, take the amount, and divide it by 30, or 40 or 50. 

Why?

On the down-side, the market could offer you margin of safety on 30 of the days that it is open in the year. On the up side, the number could be 50. We are talking about ten-year average numbers. During a singular correction, the market could offer margin of safety continually for the whole year. Decide what your magic number is. 30-40-50 days per year works ok over a ten year period. Divide the amount you’ve set aside with the number you’re comfortable with to arrive at your entry quantum per entry-day, for the year in question. Now you can keep going in with this same quantum through out the year whenever margin of safety is offered, and you generally won’t have to worry about running out of investing money, on average. 

Great stock-picking, excellent due diligence, surplus going in, small-enough entry quantum, ability to sit – the long-termer is armed with these weapons, and now, he or she can average down as much as desired, whenever margin of safety is offered.  

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