The investor’s dilemma during the Coronavirus pandemic – Explaining the Average Down Strategy

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The increase in the number of reported cases of Coronavirus created an uncertainty in the market causing sharp drop in prices. The investor’s dilemma during the Coronavirus pandemic is that the prices of investments are keeping on falling. This uncertainty is causing investors to panic and many are selling their investments at a loss – the worst that can happen.

Coronavirus pose three main problems:

1. No one knows how long the pandemic is going to last.
2. No one knows how negatively the economy is going to be affected.
3. When the pandemic ends, no one knows how long it will take for the world economies to bounce back.

As a result of the articulated problems above, future is uncertain for many investors hence the increasing level of panic. Value investors seeking long term growth of their investments are the least affected because their greatest asset is time. However, investors who are close to retirement or those expecting short term growth for their investments are left exposed. This is the investor’s dilemma during Coronavirus pandemic.

What does history say about the time it takes for the markets to bounce back from a market crash?

It took at least 1 year and up to 8 years for the S&P 500 index to recover after the previous market crashes. It is safe to say it takes a long time for the market to correct itself after a disaster.

Suppose that you are an investor managing people’s retirement money and majority of those people are going to retire in less than 1 year’s time. Are you going to fold your hands and wait for the market to correct itself? No. Remember age is not just a number on investing.

Strategies that can be implemented during Coronavirus pandemic in the stock market

Our article about investing lessons learnt during Coronavirus outbreak may be useful to you.

Let us consider the following three reactions to a market crash that do not involve panic selling:

• Strategy 1: Do nothing
• Strategy 2: Hold on and buy more shares at the lowest price
• Strategy 3: Average Down Strategy

Each of the above reactions have their own advantages and disadvantages. The second strategy (hold and buy at the cheapest later) is more theoretical because it is very difficult to time the market with precision.

Please take note:

Practical example:

Due to the Coronavirus epidemic, Stock A share prices dropped as follows:

Date	Share Price (R)
19 February	170
24 February	150
6 March	141
9 March	120
12 March	98

Suppose on 19 February an investor bought 20 shares from Stock A expecting the share price to rise (bullish market) but Coronavirus lead to drop in share prices (bearish market). We also suppose that the lowest share prices are observed on the 12^th of March and let the share price on the 13^th of April be R 137.

Under Strategy 1: Do nothing

19 February:

• an investor buys 20 shares for R 3 400 (that is 20 shares x R 170 (share price)) and then he ignores all the fluctuations in the market.

12 March:

• The value of the investment is R 1 960 (that is 20 shares x R 98 (share price)) and this translates to a loss of 42.4%.

13 April:

• The value of the investment is R 2 740.
• This is a loss of 19.4%.

Strategy 2: Hold on and buy at the lowest price

19 February:

• An investor buys 20 shares for R 3 400

12 March:

• The investor buys 50 more shares for R 4 900.
• Total investment value = (70 shares x R 98 ) =R 6 860.
• Average Cost of the investment = (R 3 400+ R 4 900)/70 shares = R 118.57 per share.
• Return = (R 6 860 – R 8 300)/R 8 300 = – 17.3%

13 April

• The value of the investment = 70 x R 137 = R 9 590
• Return = (R 9 590 – R 8 300)/R 8 300 = 16%

Strategy 3: Average Down strategy

19 February – 12 March:

Date	Share Price (R)	Number of Shares purchased	Cost of the Purchase (R)	Total Cost Of Investments (R)
19 Feb	170	20	3 400	3 400
24 Feb	150	10	1 500	4 900
6 Mar	141	10	1 410	6 310
9 Mar	120	10	1 200	7 510
12 Mar	98	20	1 960	9 470

Date	Average Cost Per Share	Investment Value (R)	Return
19 Feb	170	3 400	0%
24 Feb	163.33	4 500	-8.2%
6 Mar	157.75	5 640	-10.6%
9 Mar	150.20	6 000	-20.1%
12 Mar	135.29	6 860	-27.6%

13 April:

• Total investment value = 70 shares x R 137 = R 9 590
• Return = (R 9 590 – R 9 470)/R 9 470 = 1.3%

Summary of the three strategies

• Strategy 2 is the best but it is difficult to achieve because it is challenging to predict the lowest share price with precision. In other words, market timing is not easy.
• You lose more by doing nothing since the cost will remain at R 170 per share. Note that even though the share price increases to R 137 on 13 April, the investment is still experiencing a loss of 19.4%.
• Both strategy 2 and 3 have an effect of reducing the average cost per share and both strategies are already making profits when the share price rise to R 137.
• Strategy 3 (Average Down Strategy) is the easiest and more realistic since it does not require market timing. This is the most ideal strategy when an investor is not aware of how long the share prices are going to fall. However the higher the frequency of trading the higher the trading fees.

In conclusion, due to the uncertainties in the market brought by Coronavirus, investors need to have a good strategy that can reduce the overall damage. The Average Down Strategy is one of the best strategies that can be used to shorten the time of recovery. If an investor does nothing, the investment may take up to 8 years to start making profit after a crash. Therefore, the investor’s dilemma during Coronavirus pandemic can be eased by adopting the Average Down Strategy.