Mind melting concept of the weak

Before I fire up the engines today it is important that you know that I am not giving you specific investment advice today. We like to call this a “disclaimer”.

Okay, here we go. There is a great line in a great movie that tells us a lot about an investor’s mentality. The movie is Boiler Room, and the line is this, “I liked it at eight, and I love it at four.” Seth, the stock broker, is trying to convince one of his clients, Harry, to buy more stock. The stock has just decreased in value by half, and Seth is trying to point out that if it was a good investment at $8 per share (Harry bought numerous shares at $8/share), then it is a great investment at $4 per share. This concept is called Averaging Down. It is a hotly debate technique that has made more than a few investors go broke.

I bring this up because we are currently in a market where techniques like Averaging Down may seem like a good idea. You invest in something that seems to be a “prudent investment” and then it tanks. Sound familiar? Of course it does. Everything has tanked in the last few months. But if you were to Average Down then, not only are you all of the sudden twice as confident in the investment, but you are also putting more money at risk.

I had a friend once who had a “system” in which he played Roulette at a casino. And, as you know “systems” don’t work at casinos. The “system” was actually the same thing as Averaging Down. He would double his bet every time that he lost. This faulty method of logic assumes that you have an unlimited amount of cabbage (which you don’t), and that you are placing a bet that is consistent with the odds (which usually isn’t).

My point: I don’t have one. Kidding. My point is that due diligence is one of the most forgotten concepts in investing. Due diligence is the concept of truly investigating an investment’s quality and prudence. Most people, when trying to make a quick buck, tend to forget this. You, or your investment advisor, should be confident in every investment you make. The investment should makes sense in a good market, or a terrible market. And remember, due diligence is necessary to decide whether an investment is worth your money. In addition, your investments decrease in value shouldn’t double your belief in this investments. That just doesn’t make sense. Be patient, and don’t try to use a “system”.

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