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In this post, I will discuss the importance of “standby cash”. A simple but very important concept in the investment field.

Before that, some observations from my previous post Discount Rate is not Markup Rate (Part 2). All four investors invested in the same stock, Company ABC. However, the rate of return for each investor differs, simply because each investor purchased the stock at different months and at a different purchased price.

Investor C made a loss since the stock was purchased at the highest price while Investor D made a significant profit by purchasing the stock at the cheapest price. Ideally, every investor wants to be in Investor D’s position, buying at the cheapest price and selling at a higher price. However, this is not the case for most investors. (In my next post, I’ll share my thoughts on why we always seem to be losing our investment capital.)

I’ll be the first to admit, I was Investor C once. Chances are I will be Investor C again in the future, but that is a topic for another day. For now, let’s try dissecting Investor C’s thought process for purchasing the stock at a higher price.

Thought Process

In May, Investor C would have observed the stock price rose from RM8 in March to RM13, which indicates a clear uptrend. Based on this “historical uptrend” and the feeling of “missing an investment opportunity”, Investor C would have decided to purchase the stock in May itself. Bear in mind, Investor C had no clue the price will go down in the subsequent months. In his mind, the investment must be a sure winner based on the stock price momentum alone.

So, what can Investor C do to limit losses, better still, to make a profit out of it? The answer is simple. Never invest every single money you have at one go. Always keep some cash on the side to capitalize whenever the stock price goes down. I call this the “standby cash”.

Standby Cash Example Scenario

Let’s assume Investor C has RM30 and purchased the stock at RM13 in May. Investor C still has a balance of RM17 of “standby cash” which can be used to buy additional stocks when the price goes down. Say in July, Investor C noticed the stock price has dropped to RM7. Investor C has three options:

– sell off the investment at a loss
– wait for the stock price to move up above the purchased price (may take a long time)
– purchase additional stock at a cheaper or discounted price

Since Investor C has the “standby cash”, he/she can take up the opportunity purchasing additional stock at a cheaper price. Investor C’s total investment amount would be RM20 (RM13 + RM7) with additional RM10 of “standby cash”.

In December, the stock price is at RM11. Investor C’s position would be RM22 (2 stocks * RM11). The investment made an extra RM2 profit, which is a 10% profit of the investment amount RM20. From loss to profit! This is only possible with the existence of “standby cash”. Sure enough, there are other strategies out there limiting investment risk. I’ll write about them in future postings.

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