The Private Investor: I'll buy into making my losses look better

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The Independent Online

O Noble Bottom, now art thou truly transformed - I though that might gain your attention. It certainly did mine in the "subject" line sent in by a reader. He refers, of course, to investors finding the "bottomest bottom of this bummer of a market", and considering whether to price-average by increasing their equity stakes at the present low prices. It is an interesting question, and my correspondent's experience mirrors my own, although his is a more extreme version.

O Noble Bottom, now art thou truly transformed. I though that might gain your attention. It certainly did mine in the "subject" line sent in by a reader. He refers, of course, to investors finding the "bottomest bottom of this bummer of a market", and considering whether to price-average by increasing their equity stakes at the present low prices. It is an interesting question, and my correspondent's experience mirrors my own, although his is a more extreme version.

For example, if you bought, as I did Cable & Wireless at 200p, and again at 100p, is it is right or wise or desirable to buy again at about 50p, as I did the other day? It certainly gets the average cost down, and makes your losses look better in percentage terms, but that is a purely arithmetic gain. The strategy works, or has a chance of working only if pursued on rational grounds, that is, that you would have bought the shares anyway, regardless of your past behaviour.

So if you really do think Cable & Wireless will get over its problems then it is perfectly right to buy more at a "bargain" price. There may be a sense in which you may be prey to wishful thinking, so you ought to try to be as objective as possible, to the extent that, if needs be, you actually decide that, yes, the market may have got this one right and you decide to sell your existing holdings rather than add to it.

There is also the psychological danger that you want to see those big negative loss numbers on your spreadsheet or broker's statement get smaller so badly that the arithmetic effects become an end in themselves.

I am willing to own up to the feeling that I was guilty of this investment sin, and I added to my holdings in Marconi until it pretty much couldn't get any lower. Perhaps I should have bought a vast quantity at 1p, seeing as they now stand at 2p, but pound-cost averaging has its limits when it comes to penny/ illiquid shares.

Where I was not guilty of such sins, and reasonably well vindicated, was in the case of Vodafone, which I did indeed believe was a company with a future and where buying down to 80p worked, now that the shares have recovered to over 100p again. Much the same could also be said of my decision to add to Stagecoach when it hit its nadir at 15p or so, having since more than doubled and been sold. So I think it can work if you stay sober and keep an eye out for value. My e-mail correspondent also pointed out the difficulty with the pound-cost averaging approach which I hadn't properly thought of, and that it might tend to overweight a portfolio.

For example: If like me, your holdings are littered with telecoms shares that have been sharply marked down, then buying more at those lower levels will inevitably increase their importance in your portfolio, because you won't have been buying many more shares in sectors that have done relatively well. That may not be what you want, although of course you'd be very well placed if (when?) telecoms bounced back.

Just as John Lennon famously said that life is what happens when you're making other plans, so it is that cost-averaging may work while you are, as many of us must be, sitting around pondering its usefulness. I had been thinking for some time about adding to my holding in AWG when the news of the bid for the company came through and the price rocketed. Fortunately, it left me with the prospect of a small profit on this particular holding so I promptly cashed in. True to form I'm not quite sure what to do next, but I am examining some of those big paper lossmakers with a view to (rationally) price averaging them down.

One thing I don't think I'll be doing again is renewing my faith in friendly societies. As I've written before, I am very grateful to all those who have written in and e-mailed with details of bad experiences. I haven't, to be honest, done much on the campaign this week but I hope to write much more about the unfriendly societies, and perhaps even get some answers, next week.

s.o'grady@independent.co.uk

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