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Averaging is where you buy high and again buy lower to bring your average cost of that share down. Why do we do it? Simply because we don't want to see red in our portfolios and don't like to admit that we were wrong.
The opportunity cost of averaging is missing the chance of investing in a share that would give higher returns, specially in today's slightly bear market.
As an example, suppose someone bought 100 GREG @ 60 last year. He averaged @45 level with another 100 and averaged @ 15 with another 100, which I'm sure that many people have actually done. The average cost of 300 GREG for him now will be Rs.40 and his loss as of now will be 62.50%, assuming GREG is now at Rs.15. It'll take atleast a year for him to get any profit. On the other hand, suppose he bought 100 GREG @ 60 and not trying to averaging, bought
3000 FREE @ 2 (same amount of money he used to average GREG), and sold at 3 ( FREE actually went from 1.40 to 3.30 so we are not talking about timing the market perfectly), today he would have Rs.9000 cash and Rs.1500 worth GREG which is actually a 12.5% loss from his whole investment. (1500/12000).
The bottom line is that averaging just for the sake of seeing a little bit less red is useless. What must be done is to buy the share that you think is best from the whole market for your investment plan,
not trying to salvage the sunk cost of your previous wrong decision and cut off losses, if you can overcome your ego.
True story - At the time I started investing, a friend of mine got SHL from the IPO. Told her to sell at Rs. 25 a countless times but she didn't. She said she'll never ever sell any share at a loss ever. Recently she averaged it but still in a massive loss with no hope making a profit in the foreseeable future.
This is just my view. Contrary opinions, more examples and counter arguments are all welcome.
The opportunity cost of averaging is missing the chance of investing in a share that would give higher returns, specially in today's slightly bear market.
As an example, suppose someone bought 100 GREG @ 60 last year. He averaged @45 level with another 100 and averaged @ 15 with another 100, which I'm sure that many people have actually done. The average cost of 300 GREG for him now will be Rs.40 and his loss as of now will be 62.50%, assuming GREG is now at Rs.15. It'll take atleast a year for him to get any profit. On the other hand, suppose he bought 100 GREG @ 60 and not trying to averaging, bought
3000 FREE @ 2 (same amount of money he used to average GREG), and sold at 3 ( FREE actually went from 1.40 to 3.30 so we are not talking about timing the market perfectly), today he would have Rs.9000 cash and Rs.1500 worth GREG which is actually a 12.5% loss from his whole investment. (1500/12000).
The bottom line is that averaging just for the sake of seeing a little bit less red is useless. What must be done is to buy the share that you think is best from the whole market for your investment plan,
not trying to salvage the sunk cost of your previous wrong decision and cut off losses, if you can overcome your ego.
True story - At the time I started investing, a friend of mine got SHL from the IPO. Told her to sell at Rs. 25 a countless times but she didn't. She said she'll never ever sell any share at a loss ever. Recently she averaged it but still in a massive loss with no hope making a profit in the foreseeable future.
This is just my view. Contrary opinions, more examples and counter arguments are all welcome.
