It isn't secret that a long-term horizon is an investor's best bet. The market is volatile, and interim trading has the potential to result in major losses just as much as major gains. Long-term investing (or an increased time in the market) tends to reap more stable rewards than short-term investing (where you're timing the market). Averaging down stocks is a way for long-term investors to increase their returns, although it does slightly increase the risk involved.
What does averaging down stocks mean, and when is the best time for investors to practice it?
What is averaging down stocks?
Say you've been invested in Apple (NASDAQ:AAPL) since 2012 and you plan to stay invested at least until retirement age in 2050. Apple has been a public company since 1980 and has shown exponential potential since the early 21st century. Despite that, the company has experienced various moments of volatility over the years.
Usually, long-term investors add to their portfolios over time. Averaging down stocks is the practice of adding to your investment when the stock's value is down (i.e. a bear run). In the case of the Apple investor, they would purchase more AAPL shares on top of their existing ones during those aforementioned moments of volatility.
This serves the purpose of reducing the weighted average of your shares. In an ideal situation, it balances out your cost ratio and improves returns.
Averaging down stocks isn't selling and rebuying
Some investors online might recommend selling half of your existing shares and rebuying them at a lower price, which is risky.
The market moves quickly. In the blink of an eye, you could miss the opportunity at the bottom. Ideally, it would reduce your weighted average even more, but the risk is enhanced in this method.
In short, not all reddit advice is worth paying attention to.
Experts recommend relying on blue-chip stocks for averaging down.
Averaging down stocks the normal way isn't without risk either. If you continually invest in companies, you could choose ones that are doomed for failure. You could see a long-term reduction in share price that's hard to recover from, which makes your additional investments that much worse. In that case, you would be magnifying your losses instead of your gains—a real schmuck feeling.
For example, Beyond Meat (NASDAQ:BYND) sells vegan products and has only been public since 2019. If you've been invested since July 2019, there's a good chance you've lost some capital. It has only been a few years, but Beyond Meat has yet to prove its rebound potential. Give that company another decade or so on the market and it may (or may not) end up being a good option for averaging down.
In reality, this investing strategy is a way for you to bet on the stock's rebound potential. If it doesn't rebound, it wasn't worth it. By sticking to blue-ship securities that have proven themselves in the long term and have solid earnings reports, you're improving your chances of successfully averaging down (or reducing your weighted average). Who said long-term investing isn't exciting?