I briefly mentioned this in my previous article [My Best Investments Of The Decade p1] where I explained the thought process while deciding exactly what price to purchase an investment at, but it was worth spinning off into a separate note. All investors face what I refer to as the classic Shopper Problem:
Investors are shoppers in a marketplace, just like other shoppers in any other marketplace. When an item is on sale and being sold at a discount below our purchase price threshold (regardless of whether the discount is frequent or rare), we face the same decision. That is:
Do we buy it? (because the price has been reduced below the purchase threshold) or
Do we wait? (to see if further/better reduction in price occurs)
Unlike shopping, in most cases, there are no refunds or price matching policies. This means that whenever we buy something it uses money from our wallet/portfolio. We must make a wise decision that offers us the ability to get the most for our money. As a minimum, we would consider the following possible scenarios:
– the price may increase
– the price may remain the same
– the price may decrease
There can be a magnitude of reasons behind price changes:
– Reasons for a price increase can include sudden demand, or a lack of supply. Increases in price can result in the level remaining at a discount (just less of a discount than before), being raised back to regular full price (price discount entirely eliminated), or raised to a point of becoming over-priced. Increases can occur suddenly or gradually.
– Price may remain at the same level due to supply-demand equilibrium, or general lack of shopping activity. The price can remain at the same level for short or long periods.
– Price decreases can include reasons such as lack of interest/demand, or over supply. Decreases in the price can be small, or steep, and can occur suddenly or gradually.
All of these scenarios can possibly occur intermittently in the short term, before a prevailing scenario takes place for a more sustained period of time.
By applying these considerations to the buy/wait decision we can weigh the consequences of the three scenarios and their associated opportunity costs:
– If we buy, and use up all our cash on the purchase, that means we must give up future purchasing opportunities. We give up the chance to buy something else on sale, as well as the chance to buy more of the same thing at a lower & better price.
– If we wait and pass up the on sale completely, that means we risk losing the opportunity to get the item at the current discount price (end up paying more), and risk losing the opportunity completely. We would end up purchasing at less of a discount, or in the later case, not at all (if price rises above our purchase price threshold).
Some things to consider :
We could spend only a portion of our allocated cash, while holding some back to wait for even better pricing. Although the same problem exists, the exception is that we only risk losing the opportunity to acquire more at the same price using the remaining allocated amount. Pricing levels can become better (if prices decrease), or worse (pricing increases). But we do not risk losing the opportunity completely (if prices rise above purchase threshold) because we have already acquired a portion.
In the two cases where we spend a portion, or we don’t spend any at all (we wait), if the opportunity for better pricing never occurs, the unused cash must then be used on a similar item that fits the role in the investment plan. Losing the opportunity to use the allocated cash means that we would have to look at other alternatives. The alternatives may be potentially less efficient due to lower quality, significant defects, or may not be as good of a fit. Sticking only with investment candidates that have high quality, high return, and high safety (low risk) means our choices are much more narrow as well. Like shoppers, investors cannot predict the level of the lowest price, or the direction of pricing. Therefore this decision must be made each time investment capital is to be used.
The second part of the classic Shopper Problem for investors is not having enough money (investment capital) in our wallet when we see a sale. But accumulating capital is another story all together.
For investors first starting out, read my article on personal finance for some simple methods & ideas to find additional capital (Raising Capital) for investing, Personal Finance III – Practical Steps. I highly discourage using other “advanced” techniques that you may hear about from other investors, until further knowledge & experienced has been gained. Otherwise more harm than good will likely occur. Unfortunately, for my more advanced readers, I have yet to discuss this topic online in any detail. However, anything I’ve mentioned offline would still apply.
Thanks & Happy Investing! — The Investment Blogger © 2010