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The Art of "Doubling Down"
By Stephen J. Butler |
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A book called, "Is there Life After High School?" offers a collection of stories about how we all remember so much about that intense period of our lives. Someone who was asked what they thought was most important about high school summed it up by saying, "everything was important." The same is true with our mutual fund and investment statements at the high point of their value back on March 31st of 2000. We can all pretty much recall what we were worth at about that time, and we wring our hands when we look at them now.
Those of us who feel like we've since been mugged by our formerly red-hot technology stocks and even our S&P 500 index can simply come to terms with what steps to take next. While it is depressing to look at recent 401(k) statements, it may pay to suck it up, display some fortitude...and buy some more of what ails us.
The natural reaction of most people has been to stop throwing good money after a bad investment and to reallocate inbound retirement plan contributions to more conservative investments. Meanwhile, most of us have been too traumatized to do anything but to hold on to those stocks whose substantial losses have created mayhem in our portfolios. This is one case where investment inertia serves us well.
Several technology funds have lost over 50% of the value they enjoyed at the end of 1999. This is a huge loss. To recover from losing 50%, a fund has to now double in value or gain 100%. This may take time. At an average compound return of 10% per year, it will take 7.2 years to generate returns that will bring it even again.
Generally speaking, however, a collection of technology stocks is volatile and can go off like rockets when markets turn around. Witness the 200% gains that several made in the two years of '98 and 99. And, bear in mind that a 200% return turns $1,000 into $4,000.
"Doubling down" is a term that describes the purchase of additional shares of a declining stock or mutual fund. The basic objective is to reduce the average cost of all of your shares so that when markets rebound, you will break even again at a lower share price. It takes nerves of steel to invest in a "loser" but nerves of steel and unemotional behavior are traits that distinguish successful investors.
The arithmetic is simple. If you had $10,000 invested in a fund that has now dropped to $5,000, you can recover your loss faster by investing another $10,000. This will reduce your "breakeven point" to just a 33% gain rather than the 100% gain requirement described earlier. If you invest just $5,000 more, you reduce your "breakeven point" to a 50% gain. When they are hot, these volatile funds can reasonable be expected to generate these gains.
To review my arithmetic, let's say you have 100 shares of a fund you bought at the top of the market for $10 per share. It has since tanked to $5 a share. You invest another $1,000 and buy 200 shares at today's $5 price. Now you have a total of 300 shares you have bought for a total of $2,000. Your average price is $6.67 per share. When the share price rises from $5 to $6.67 (a 33% increase) you will have broken even. Otherwise, you will have to wait until the stock doubles in value (100% gain) before you find yourself even again. This all assumes, of course, that you bought your fund at the high. (We all tend to remember the highest past value of our accounts.) In fact, you probably bought it in stages and benefited from at least some of the increase in value. The average price of all of your shares is probably less than the $10 we remembered as being the top of the market.
Inside a retirement plan, you can ignore tax considerations. For assets subject to taxes, however, you can add another level of sophistication to the process of doubling down. You can sell the fund shares and buy them back 31 days later and proceed with your program to lower your average cost. Now, you have a tax loss that you can use to offset other gains or to carry forward into future years. Remember that saving taxes is just as valuable as making a profit on an investment. You can reinvest any money that would otherwise have been owed to the government.
Nattering nabobs of negativism are always quick to point out that the period from 1964 to 1981, a seventeen-year period, generated just a one percent gain in the Dow. However, this obscures the amount of money that people made who continued to save and invest by dollar-cost averaging throughout that period. Unfortunately, there weren't many because most people beat a hasty retreat from the market at the time. This time it's different. Those of us saving for retirement have new money rolling into our accounts on a monthly basis. For this new money, the concept of doubling down on some former losers may prove to be a better strategy than our natural instinct to invest this money conservatively.
The securities markets are subject to the risks of fluctuating prices and the uncertainty of rates of return and yields inherent in investing and past performance is no guarantee of future results. |
