MythBusters - Lowering Your Cost Per Share
Monday, March 30th, 2009
Welcome to the first, and probably only, special MythBusters OneSeasonNation edition. Tonight, I will attempt to debunk the myth of buying into a loser you are holding in an attempt to “lower your cost per share.”
All to often on the Nation forums I hear people talking about their investments in an, economically speaking, backwards thought process. members are displaying what I feel is a widespread fundamentally flawed strategy of trading on oneseason. Rylin34 made a post today and scratched the surface of my point, but even he doesn’t go far enough in my opinion.
Rylin34: “It has been said time and time again, but the only reason you sell at a loss is because there is a better opportunity to regain money or you think prices are going lower (rebuy once you think the prices have bottomed). Selling for a loss permanently locks in that loss and that money is gone forever, unless either option is available in my point above. Losers buy high and sell low. Patience is the key right now.”
Maybe it has been said time and time again, but I feel people continue to ignore it and refer to lowering their cost per share as if it is the best strategy, when 9 times out of 10, its not. Just look at what Rylin said… “the only reason you sell at a loss is because there is a better opportunity to regain money or you think prices are going lower (rebuy once you think the prices have bottomed).”… So essentially, the “only reason” to sell at a loss is when any other investment would be a better one. Or in other words, you should be buying the best possible investment, regardless of what you currently own. DUH!
As simple and obvious as that sounds, the very idea of buying in order to lower your cost per share goes against this and yet I see people saying that is exactly what they are doing all the time. Color me confused.
Let me introduce you to a couple terms… first, sunk cost: In economics and business decision-making, a sunk cost is a cost that can not be recovered once it has been incurred. Next, variable cost: costs that will change depending on a proposed course of action.
In microeconomic theory, only variable costs are relevant to making a decision
What does this all mean for OS… When you spend 10 dollars on an SOI, it is gone, the only value you ever have after that is the current price at which you could sell your shares. That 10 dollars is a sunk cost… Too often people get emotionally attached to their sportfolios, refusing to sell while in the red (saying things like, I’ll sell as soon as I break even on my investment), when in truth, what you spent on the SOI should have no barring on what you do in the future.
What you should be looking at is your variable costs. 2 days later that 10 dollar SOI you bought is worth 5 dollars (and for arguments sake, say there is a sell order out there for 5 dollars), so what do you really have? You have 5 dollars in value, plain and simple… You do not have 10 dollars, you threw that away days ago with a bad investment, so rather than be stubborn (I see the word “patient” often incorrectly used in its place) about it and refuse to sell until your positive, why not make the best of a bad situation? Right at that moment you should be weighing all the possible places you could invest that 5 dollars…
If you believe the market is going to go down and there is not a safe bet to make money, then you should sell your share and wait. Why watch your remaining 5 dollars dwindle down to 2.50 before going back up, when you could sell now and buy back later… If you believe ANY OTHER investment is a better one at that moment, then selling your current SOI and buying the better one should be your next course of action. From an emotional standpoint it may be hard to sell in the red, but if you can make more money on another player, you are only hurting yourself and compounding a mistake by holding… If you believe your current SOI is the best investment in the market, then you should continue to invest in that SOI. But keep in mind why you are doing it, not because you want to make that money back, but rather because you actually feel it is the best investment.
Everyone’s opinion on what is the best investment differs (it is what makes the market great), so while others may not agree with you, at least you are using sound business decision making… It’s when people blindly disregard logic and continue to buy more of a losing stock so that they can lower their price per share that they get in trouble. Is it really doing you any good to spend 100 bucks to lower your price per share on an SOI closer to its actual price, when you could have spent that money on a different SOI? Unless you truly believe the first one is the best investment on the market, its not… It may seem like you are making progress, because your price per share has dropped to 6 dollars instead of 10, but you are chasing a meaningless figure. All that matters is how much you think you can make with the money you currently have. If I project Arod, whom I own at a loss, to gain 10% the next month while I project Pujols, who I don’t own, to gain 15% in the next month, you tell me who i should spend that 100 dollars on. It seems silly to buy Arod to lower my price per share, when i could own Pujols and make more money. “Selling at a loss” to pickup Pujols is not a stupid thing because that term is deceiving. You have already incurred the loss, it is sunk, there is nothing you can do about it. By not making the economically sound decision going forward, that is the stupid thing to do…
I’ll leave you with this… lowering your price per share should not be a motive for buying more SOI’s (which by reading many of our post, seems like it is), it should only be the result of making the correct business decision. I hope that going forward people will start to understand the faulty logic behind these common practices…
I welcome your comments and discussion on this topic! ~Bill2451
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