Mental Models discussed in this podcast:
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You can find out more information by listening to episode 11 of this podcast.
When NOT to average down – Show Outline
The full show notes for this episode are available at https://www.diyinvesting.org/Episode40
What is averaging down?
- Averaging down is the process of buying additional shares of stock as the stock price declines.
- This lowers your average price of acquisition for a stock.
- The last time I discussed investment rules was about lessons learned from my investment in GameStop. Today, we focus on new lessons learned from other people’s experience:
- In particular, Bill Miller and the lessons learned from him by John Hempton at Bronte Capital.
Cheaper is not always better when it comes to portfolio management
Three new investment rules
- Do not average down on a highly leveraged business model.
- Do not average down on an operationally leveraged business that is declining
- Do not overage down where the primary risk is obsolescence.
90% decline vs 95% decline
A stock that is down 95% is not substantially better than a stock down 90%.
However, they may appear similar when superficially compared. Yet, the additional 50% decline needed to reach 95%, doesn’t necessarily equate to a bargain.
Always avoid going back to zero
- Bankruptcy risk is the primary concern that you are trying to avoid with these new investing rules.
- Leveraged companies, in particular, have a higher than average bankruptcy risk.
Cheaper is not always better when it comes to portfolio management. Once you have hit your investment allocation for a position it can be a mistake to throw good money after bad. Assuming your investment analysis is correct, you will still end up making money. Yet if you are wrong, you will exasperate a bad situation by averaging down on a losing leveraged position.
A full list of my investing rules available on DIYInvesting.org