Sometimes a stock moves downward and creates what we consider a buying opportunity. We apply the term when we feel an attractive stock has dropped in price for reasons that are of a passing nature, or that are exaggerated in investors’ minds.
This shouldn’t be confused with “averaging down.” That’s when you buy more of a stock you own that has fallen in price, mainly to lower your average cost per share. The problem here is that you are picking stocks for your portfolio investing based on a single factor: the drop in the price of the stock — and not the company’s overall investment quality.
This focus on share price can be highly detrimental to your portfolio investing results over the long term. For that reason, we never average down for its own sake when we manage the portfolios of our Successful Investor Wealth Management clients.
Focusing your portfolio investing on share prices — and not investment quality — will eventually cost you money
Some investors go through a phase when they reflexively buy more of anything they own that goes down, as if to validate their decision to buy it in the first place. Stocks sometimes go down due to random fluctuations and misinformed selling. But they also fall because of negative factors that the public does not yet know about or appreciate.
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In the case of aggressive stocks, averaging down can be one of the worst portfolio investing mistakes you can make. That’s because there are more likely to be hidden risks in aggressive stocks.
With conservative stocks, averaging down is still risky. Good stocks do go bad. Stocks that are generally considered conservative do sometimes turn out to be anything but. That’s why we always recommend that you check for changes in our buy/sell/hold advice before you buy more of a stock that has dropped significantly.
If we continue to recommend the stock as a buy, that means we think the stock will turn out okay. But it’s important to note that no one can predict such things with 100% certainty. Moreover, you should also weigh the impact that buying more of the stock would have on your portfolio. If buying more would put the stock above, say, 5% of your overall portfolio, we would advise against it.
Average down by coincidence — not by design
To succeed as an investor, you need to diversify, and you should never make the mistake of focusing your portfolio investing too heavily on any one stock, regardless of how certain you are about its future.
Let’s put it this way: The only time it pays to average down is when it’s a coincidence. You want to buy more of a stock because it’s attractive, not because you bought it at higher prices.
If you’d like me to personally apply my time-tested portfolio investing approach to your investments, you should consider becoming a client of my Successful Investor Wealth Management service. Click here to learn more.
