When to Double Down In Investing

Here is a recent question that I got from a reader:

Warren Buffett: If You Own A Good Business, Keep It

Berkshire Hathaway Warren BuffettBuying private businesses is easier than acquiring public firms, and investors should avoid selling good investments at all costs, according to the Oracle of Omaha, Warren Buffett. Q2 2020 hedge fund letters, conferences and more In an interview with CNBC in March 2013, Buffett was asked if he was looking at any businesses, in particular, Read More


I have a question for you that I don’t think you’ve addressed in your blog. Do you ever double down on something that has dropped significantly beyond portfolio rule VII’s rebalancing requirements and you see no reason to doubt your original thesis? Or do you almost always stick to rule VII? Just curious.

Portfolio rule seven is:

Rebalance the portfolio whenever a stock gets more than 20% away from its target weight. Run a largely equal-weighted portfolio because it is genuinely difficult to tell what idea is the best. Keep about 30-40 names for diversification purposes.

This rule is meant to control arrogance and encourage patience. I learned this lesson the hard way when I was younger, and I would double down on investments that had fallen significantly in value. It was never in hope of getting the whole position back to even, but that the incremental money had better odds of succeeding than other potential uses of the money.

Well, that would be true if your thesis is right, against a market that genuinely does not understand. It also requires that you have the patience to hold the position through the decline.

When I was younger, I was less cautious, and so by doubling down in situations where I did not do my homework well enough, I lost a decent amount of money. If you want to read those stories, they are found in my Learning from the Past series.

Now, since I set up the eight rules, I have doubled down maybe 5-6 times over the last 15 years. In other words, I haven’t done it often. I turn a single-weight stock into a double-weight stock if I know:

  • The position is utterly safe, it can’t go broke
  • The valuation is stupid cheap
  • I have a distinct edge in understanding the company, and after significant review I conclude that I can’t lose

Each of those 5-6 times I have made significant money, with no losers. You might ask, “Well, why not do that only, and all the time?” I would be in cash most of the time, then. I make decent money on the rest of my stocks as well on average.

The distinct edge usually falls into the bucket of the market sells off an entire industry, not realizing there are some stocks in the industry that aren’t subject to much of the risk in question. It could be as simple as refiners getting sold off when oil prices fall, even though they aren’t affected much by oil prices. Or, it could be knowing which insurance companies are safe in the midst of a crisis. Regardless, it has to be a big edge, and a big valuation gap, and safe.

The Sense of Rule Seven

Rule Seven has been the rule that has most protected the downside of my portfolio while enhancing the upside. The two major reasons for this is that a falling stock triggers a thorough review, and that if I do add to my position, I do so in a moderate and measured way, and not out of any emotion. It’s a business, it is not a gamble per se.

As a result I have had very few major losses since implementing the portfolio rules. I probably have one more article to add to the “Learning from the Past Series,” and the number of severe losses over the past 15 years is around a half dozen out of 200+ stocks that I invested in.

Summary

Doubling down is too bold of a strategy, and too prone for abuse. It should only be done when the investor has a large edge, cheap valuation, and safety. Rule Seven allows for moderate purchases under ordinary conditions, and leads to risk reductions when position reviews highlight errors. If errors are eliminated, Rule Seven will boost returns over time in a modest way, and reduce risk as well.

Previous articleSamsung Galaxy View Tablet To Deliver 18-Inch Plus Display
Next articleGreat, great chart. #markets #correction
David J. Merkel, CFA, FSA — 2010-present, I am working on setting up my own equity asset management shop, tentatively called Aleph Investments. It is possible that I might do a joint venture with someone else if we can do more together than separately. From 2008-2010, I was the Chief Economist and Director of Research of Finacorp Securities. I did a many things for Finacorp, mainly research and analysis on a wide variety of fixed income and equity securities, and trading strategies. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm. From 2003-2007, I was a leading commentator at the investment website RealMoney.com. Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and I wrote for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I no longer contribute to RealMoney; I scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After three-plus year of operation, I believe I have achieved that. Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life. My background as a life actuary has given me a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that I will deal with in this blog. I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.