If throwing good money after bad is generally a bad idea, is throwing more money after good Ok?

Question

I have heard that investing more money into an investment which has gone down is generally a bad idea*. "Throwing good money after bad" so to speak.

Is investing more money into a stock, you already have a stake in, which has gone up in price; a good idea?

Doing that sounds good, but then I look at my percentage gains, they go from a nice 20% gain to a mediocre 10% (for example). I am also worried that I may end up doubling down on, what will turn out to be, a bubble.

Fore what its worth my general investing strategy is 'Buy and hold'.

*I imagine an exception to this rule is long term progressive (some every pay check) in index funds.

Answer 1

The response to this question will be different depending which of the investment philosophies you are using.

Value investors look at the situation the company is in and try to determine what the company is worth and what it will be worth in the future. Then they look at the current stock price and decide whether or not the stock is priced at a good deal or not. If the stock price is priced lower than they believe the company is worth, they would want to buy stock, and if the price rises above what they believe to be the true value, they would sell. These types of investors are not looking at the history or trend of what the price has done in the past, only what the current price is and where they believe the price should be in the future.

Technical analysis investors do something different. It is their belief that as stock prices go up and down, they generally follow patterns. By looking at a chart of what a stock price has been in the past, they try to predict where it is headed, and buy or sell based on that prediction.

In general, value investors are longer-term investors, and technical analysis investors are short-term investors.

The advice you are considering makes a lot of sense if you are using technical analysis. If you have a stock that is trending down, your strategy probably tells you to sell; buying more in the hopes of turning things around would be seen as a mistake. It is like the gambler in Vegas who keeps playing a game he is losing, hoping that his luck changes.

However, for the value investor, the historical price of a stock, and even the amount you currently have gained or lost in the stock, are essentially ignored. All that matters is whether or not the stock price is above or below the true value determined by the investor. For him, if the stock price falls and he believes the company still has a high value, it could be a signal to buy more. The above advice doesn't really apply for them.

Many investors don't follow either of these strategies. They believe that it is too difficult and risky to try to predict the future price of an individual stock. Instead, they invest in many companies all at once using index mutual funds, believing that the stock market as a whole always heads up over a long time frame. Those investors don't care at all if the prices of stock are going up or down. They simply keep investing each month, and hold until they have another use for the money. The above advice isn't useful for them at all.

No matter which kind of investing you are doing, the most important thing is to pick a strategy you believe in and follow the plan without emotion. Emotions can cause investors to make mistakes and start buying when their strategy tells them to sell.

Instead of trying to follow fortune cookie advice like "Don't throw good money after bad," choose an investment strategy, make a plan, test it, and follow it, cautiously (after all, it may be a bad plan).

For what it is worth, I am the third type of investor listed above. I don't buy individual stocks, and I don't look at the stock prices when investing more each month. Your description of your own strategy as "buy and hold" suggests you might prefer the same approach.

Answer 2

I have heard that investing more money into an investment which has gone down is generally a bad idea*. "Throwing good money after bad" so to speak.

This is over simplified statement to explain the concept.

What is essentially says is;

Say I hold stocks of XYZ; 100 units worth say USD 1000. This has lost me x% [say 50%].
The general tendency is to buy 100 more units in anticipation / hope that the price will go up. This is incorrect.

However on case to case basis, this maybe the right decisions. On a periodic basis [or whenever you want to invest more money]; say you have USD 1000 and did not have the stock of XYZ, will you buy this at current price and outlook of the company. If the answer is Yes, hold the stock [or buy more], if the answer is no sell the stock at current market price and take the loss.

The same applies when the price has appreciated. If you have USD 1000; given the current price and future outlook, will you buy the specific stock. If yes, hold the stock [or buy more], if answer is no sell the stock and book profit.

Off-course I have not overlaid the various other considerations when buying stocks like diversification, risk profiles of individual stocks / segments, tax implications etc that are also essential even if you decide to buy or sell specific stock.

Answer 3

The principle behind the advice to not throw good money after bad is better restated in economics terms: sunk costs are sunk and irrelevant to today's decisions.

Money lost on a stock is sunk and should not affect our decisions today, one way or the other. Similarly, the stock going up should not affect our decisions today, one way or the other. Any advice other than this is assuming some kind of mispricing or predictability in the market. Mispricings in general cannot be reliably identified and stock returns are not normally predictable.

The only valid (efficient markets) reason I know of to allow money you have lost or made on a stock to affect your decision today is the tax implications (you may want to lock in gains if your tax rate is temporarily low or vice versa).

Answer 4

I have heard that investing more money into an investment which has gone down is generally a bad idea*. "Throwing good money after bad" so to speak.

Is investing more money into a stock, you already have a stake in, which has gone up in price; a good idea?

Other things being equal, deciding whether to buy more stocks or shares in a company you're already invested in should be made in the same way you would evaluate any investment decision and -- broadly speaking -- should not be influenced by whether an existing holding has gone up or down in value.

For instance, given the current price of the stock, prevailing market conditions, and knowledge about the company, if you think there is a reasonable chance that the price will rise in the time-period you are interested in, then you may want to buy (more) stock. If you think there is a reasonable chance the price will fall, then you probably won't want to buy (more) stock.

Note: it may be that the past performance of a company is factored into your decision to buy (e.g was a recent downturn merely a "blip", and long-term prospects remain good; or have recent steady rises exhausted the potential for growth for the time being). And while this past performance will have played a part in whether any existing holding went up or down in value, it should only be the past performance -- not whether or not you've gained or lost money -- that affects the new decision.

For instance: let us suppose (for reasons that seemed valid at the time) you bought your original holding at £10/share, the price has dropped to £2/share, but you (now) believe both prices were/are "wrong" and that the "true price" should be around £5/share. If you feel there is a good chance of this being achieved then buying shares at £2, anticipating they'll rally to £5, may be sound. But you should be doing this because you think the price will rise to £5, and not because it will offset the loses in your original holding.

(You may also want to take stock and evaluate why you thought it a good idea to buy at £10... if you were overly optimistic then, you should probably be asking yourself whether your current decisions (in this or any share) are "sound").

There is one area where an existing holding does come into play: as both jamesqf and Victor rightly point out, keeping a "balanced" portfolio -- without putting "all your eggs in one basket" -- is generally sound advice. So when considering the purchase of additional stock in a company you are already invested in, remember to look at the combined total (old and new) when evaluating how the (potential) purchase will affect your overall portfolio.

Answer 5

To expand a bit on what TripeHound said in the comment section, past performance is not indicative of future performance, which is why the best advice is to ignore if you already own the stock or not.

If the stock goes down, but you've done your research and think it will come back, then investing more isn't a bad idea. If the stock is doing well and it will continue to do well, then invest more. Treat investing more into a stock you already own as a new investment and do your research.

TL;DR of your question, it's a very case-by-case basis

Answer 6

Is investing more money into a stock that you already have a stake, in which has gone up in price a good idea?

What you describe here is a good idea when the stock keeps up-trending. The way to do it is say you have originally bought $1000 worth of shares, then the next purchase you buy $500 worth, then $250 worth. It is called pyramiding into your trades.

However, this system would not be the best with simply a buy and hold when you keep holding even if the price starts freefalling. You would need to have a trailing stop loss on your initial trade, and then as you buy each additional trade your trailing stop loss would incorporate the additional trade and move to a level where if you get stopped out you will make an overall profit.

With each additional trade your trailing stop will move higher and higher for higher protected profits.

The whole point behind pyramid trading is to keep buying more of a stock that keeps performing well to increase your profits. However, each additional purchase is half the previous one so that you don't eat too much into existing profits (in the case of the uptrend reversing) and so as to not overcapitalise on the one stock. So you are using part of your existing profits in an attempt to make more profits.