The myth
When the price of an investment goes down, some of its current investors may sell in a panic, while others may hold off on putting in more money until they get some clarity.
There are also those who view the drop as a good opportunity to buy and accumulate more.
Since they found the investment attractive even at a higher price, they believe buying more after the price falls is like getting it “on sale.”
The reality
Buying more of an investment after its price drops is called averaging down. The idea is that by purchasing at a lower price, you reduce the average cost of all your shares of this product.
If your timing is right and the price goes back up, averaging down can allow you to recover losses sooner and even maximize your profits if the asset continues to grow.
However, if you made the wrong call, you may end up catching a falling knife. This expression refers to a situation where you buy an investment after a price drop, hoping to profit from its eventual recovery, but the opposite happens, and it keeps falling.
Here are a few signs averaging down might or might not work for you:
When it may not work
- You bought more of an investment simply because of the price, and without looking into its real value and growth prospects.
- The dip in price is a warning sign of bigger trouble to come. You’ll end up trapping more money in a bad investment.
When it may work
- The company or investment is fundamentally strong, and the rough patch is temporary.
- You plan to hold on to the investment for a long time and can wait for it to rebound.
- You understand the risks and can handle short-term losses.
Of course, even if you’ll try your best to make an informed decision, it can still be impossible to predict with 100% accuracy how an investment will perform.
It helps if your investments are properly diversified and a loss in 1 asset wouldn’t hurt your entire portfolio significantly.
Verdict: It depends.
Just because something is cheaper doesn’t always mean it's a good deal, even in investing. It can be risky to average down if you’re acting on impulse and don’t understand why the price is falling.
This method might pay off if you truly believe in an investment since you’ve done your research and can afford to wait out the decline.
