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What Is Averaging Down?

moneyAveraging down is what happens when investors buys more shares in a company at a lower price, which effectively brings down the average cost of holding shares in the business

Let’s say you bought 1,000 shares in a company at a price of $1. Your initial investment is $1,000. However, for whatever reason, the share price of the company subsequently falls to $0.50. It means that the paper loss on your investment is $500.

If you now buy another 1,000 shares at $0.50, that would bring your total investment in the company to 2,000 shares for a total cost of $1,500. So, the average cost of your investment is now $0.75. Consequently, your paper loss per share is now $0.25 rather than $0.50.

There are a couple of things to note here. Firstly, your paper loss hasn’t changed. It is still $500 even though the loss per share is down from $0.50 to $0.25. Secondly, the $1,000 that you have just spent on buying more shares can’t be used anywhere else. After all, you can’t spend the same dollar twice.

Whether to average down is contentious. Some investors believer that a fall in the price of a share provides an opportunity to buy more of something that you like at an even better price. Others reckon that it could be throwing good money after bad. They are both right and they are both wrong.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore Director David Kuo doesn’t own shares in any companies mentioned.