Investing psychology : averaging up

I had a very brief conversation over lunch with a friend just several weeks ago. After an exchange of pleasantries and knowing that he invests in stocks, it was natural that our talking conversation centred around stocks. I asked him if he had managed to pick up any good stock during last year when Covid-19 was its worst. He replied negative. His reason was he was trying to time to get the lowest price for a particular stock. (Frankly I do not know which stock he was eyeing.) He was then working from home and was a buyer for an electronic manufacturing company. It was possible that he missed out the purchase as it had been a relatively hectic period for corporate buyers due to the huge demand for electronic components caused by the pandemic. Despite the hectic period, he admitted that he had a little bit of time to look at the stock market.

In another instant, I came to realise a close friend of mine also invested in stocks as I was trying to what’s app to some of them to market a new online course at that time. He is working in a ‘relatively-safe’ corporate.  He divulged he had stocks in Sembcorp Industries, Keppel Corporation, SPH and maybe, one or two more. While I did not want to ask too much of his stock portfolio, it seemed that his stock investment has been quite narrow, limited to only government-linked or quasi-government type of listed companies. It might be  due to his working environment and his background. Nothing wrong with those. He told me he lost money overall, especially for SPH, which he had bought at a high average price. He asked me if SIA was a good buy, and I told him not to focus too much on bombed-out counters. We might get a very short-term gain, but fundamentally the stock price did not move very much even in the past 10 years before the pandemic. So, what made him thought that after rights issue, the bombed-out counter would rise in price going forward. The possible fund-raising exercises in the years ahead could be a black hole, which I cannot predict. Given that he was still in the red, focusing on SIA was probably not the best policy. As we know, SIA was having a bad time and SPH stock price was roiling in a downward sloping manner day-by-day in 2020. Naturally I would never even want to mention them, let alone to recommend them. I was not closely following Sembcorp Industries, but I believe it too was not exactly in a great position as well, post the de-merger with Sembcorp Marine. Of all, Keppel Corporation was probably worth a mention as he already had some shares but was still in the red as it was dropping gradually from about $9.00 following the oil price crash in 2016. At that time in the what’s app conversation, the share price was trading at around $4.50. Given his relatively ‘safe type of portfolio’ (‘safe’ from the perspective that they probably would not go bust, but certainly, ‘not safe’ given the magnitude of the losses), I told him perhaps he would consider to average down Keppel Corporation and buy new into ComfortDelgro (CDG) as there were trading below or near to their book value. I cannot say that they were trading at their lowest price, but they were trading at a ‘good price’ at that time. Just a few weeks after lockdown was lifted when stock prices were in a rage, I what’s app him again if he had bought any stocks. He told me that he did not pick up anything as he was busy at work.     

In yet another conversation with a very close relative, she mentioned she wanted to have DBS shares. It was probably in September 2020 when DBS was trading just below $20 for a few days. While I was not able to give a definite answer (for I am not god) that it would not fall in the days ahead, my answer was that if she felt it was a good price, she should go ahead and buy it. If anything, manage it later. Think long-term. No need to consider too much. The fact that she called me (which she never ever did in the past) was that she believed that DBS was trading at a good price at that time. She just seemed to want to seek a second opinion that she was right. What was the situation after that?– No action on her part.       

Nothing wrong or against any of them, but certainly, there was something common in them.  They procrastinated when they were making buy decisions on the stocks. They wanted the best price. As human beings, it is always natural that we want to buy stocks at their lowest price. We look at stocks as if we are going out shopping. Not only we want to get discounts, we want to get the best discounts (better still, a discount after a discount). Maybe, that could give us a good bragging right for our investing prowess. But this, by itself, is a limiting belief. Many may not have realised it. So what if we had bought a stock at its lowest price. If we had bought a stock at its lowest price, do we want to stop there? Assuming that one wanted to buy the stock again given its ‘great upside potential’, he definitely is not going to be able to buy at that ‘great price’ anymore. And because he is not able to buy at that great price, he waited, he procrastinated but the stock is not going to wait for him. In the end, at best, he only managed to have one good bite on the cherry. On the other hand, another person felt that he had bought at a relatively good price in the same circumstance, and bad luck, the stock price went down further. His propensity to buy more is higher because he believed that he had already bought the stocks for a good price in the first place. And when the stock dropped further, he would have the tendency to buy more to take further advantage of a further discount unless he runs out of money. But when the stock did turn around convincingly, who actually has the last laugh?

Let’s take an example. Stock X is now trading at $1.50. Both A and B felt that the stock price is sufficiently low. Mr A wanted to wait further for the lowest price. So he waited. Mr B thought it was a good price, and he bought 5,000 shares. But good for Mr A and bad for Mr B, the stock price indeed dropped further to say $1.20 a month later. Mr A and B decided to buy 5,000 shares each. The share positions of Mr A and Mr B are as follows:

Let’s say, in another 2 months down the road, the stock price of Stock X turned around to say $1.80. Who actually gained more? Let’s calculate. Mr A would have gained $3,000 [5,000x($1.80-$1.20)] and Mr B would have gained $4,500 [10,000 ($1.80-$1.35)]. Even though the average price of Mr A is lower than that of Mr B, Mr B is the ultimate winner. Of course, one may argue that Mr A could have invested a quantity of 10,000 shares instead of only 5,000. Indeed. But, the fact that Mr A procrastinated to look for the lowest possible price is quite telling that he is unlikely to go beyond his comfort level to buy more. (Of course, in the real world, some would but there are definitely many others who don’t.)

While this is just one simple case out of the infinite possibilities and reactions of investors and traders out there in the real world, it speaks volumes about how our mind is conditioned to the type of setting and the environment that we have been brought up.  

I, for one, have this limiting belief as well. I used to look at the directors’ purchase price of the stocks they own gleaned from The Business Times. When they purchased a stock at say, $1.60 per share and when I purchased the same share at a lower at $1.50., I felt victorious as they purchased at higher price than me. But, it was a different playing field.  I could only, at best, purchased one board lot (used to be 1000 shares) with my limited resources but they can purchase 100 lots (or 100,000 shares) of their company stocks. When the stock rose to say $1.80, my gain was only $300, but their gain was a whopping $20k even though they had purchased the stock at a higher average price. It’s really all in our mindset.   

In the real trading, I had such experience many times in the past and is still happening today, consciously or unconsciously. When I managed to buy OSIM at $0.086, it was a great price. I had more than the share quantity I had initially wanted to invest. It had a good run, twenty-two quarters of growth pushing the stock price to nearly $3.00 per share since its huge loss in 2008. Twenty-two quarters of growth would have translated to 5½ years of upside. It is certainly long enough time to make multiple purchases. While I am proud to have enjoyed a multiple-bagger stock, I probably would have made more if I had let go of the mindset of clinking to maintain my average price. (In fact, some people around me were even asking me to to sell during those few years given that the stock price had gone up by multiple times.) My limited resources without an active income, the thought that the whole family’s expense depended on me, and certainly, the fear that the stock could make a U-turn downwards had also imposed a huge restraint to average up on this stock. In hindsight, should I have averaged up, of course, my average price would be higher, but the gain would have been more significant in the end.      

In the meantime, I had bought into Venture Corporation during the Global Financial Crisis at an average price of $6.876. It was definitely not the best price at that time, but it was a good price in hindsight. For a long time in the next 6½ years,  I did not made a single purchase for fear of averaging up. Only to realise that I have missed quite a huge upside gain. After all, the price of Venture Corporation did not go up significantly hovering near to $10 per share during those years, until somewhere in 2017 when it headed up for the sky landing close to $20 today. My realisation came a little too late. My average price was much higher even though I am still on the positive side today.

Interestingly, I had a better luck in DBS. My average price was about $12.23 after the rights issue during the global finance crises. Realising that I am missing out the big picture, I decided to buy the stock in the open-market step-by-step. Today, it has been very much better off based on the quantity at a higher average price of $14.39 compare to the original holding quantity at the much lower average price at $12.23.

It’s all in our mindset. The use of some simple arithmetic could go a long way to help us formulate the investing roadmap. Generally, if a stock is in the upward direction, averaging up may not be so bad. The only fear is that when it slammed down and we sell them in a panic.               

Brennen has been investing in the stock market for 30 years. He trains occasionally and is a managing partner for BP Wealth Learning Centre. He is the instructor for two online courses on InvestingNote – Value Investing: The Essential Guide and Value Investing: The Ultimate Guide. He is also the author of the book – “Building Wealth Together Through Stocks” which is available in both soft and hardcopy.

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