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“BUYING THE DIP.” It’s a phrase often uttered with contempt by Wall Street strategists and money managers, who look down their nose at everyday investors who instinctively shovel more money into stocks simply because share prices have fallen.
Commentators “caution against” it, dismiss it as “not an investment strategy,” predict it’s going to “die,” argue it could get “very, very nasty” and contend that—when everyday investors buy on dips—it’s a “contrarian signal.” And I got all that based on a quick internet search.
Guess what? I love buying the dip.
It’s been a huge contributor to my financial success—to a degree that’s almost embarrassing, because buying the dip can seem perilously close to market timing. But it really isn’t. Market timing is about predicting which way the stock market is headed and then making major portfolio shifts from stocks to cash, or vice versa. It’s a strategy that’s rightfully frowned upon, because there’s no surefire way to forecast what will happen next in the stock market.
By contrast, when you invest more in stocks during a market dip, you aren’t guessing the market’s direction. Instead, you’re reacting to what the market has already done. In that sense, it’s similar to rebalancing. When you rebalance, your goal is to bring your portfolio back into line with your target asset allocation. When you buy the dip, you’re helping that goal along—and, if it means you’re adding new savings to your overall portfolio, that’s all the better.
But isn’t it naïve to buy stocks simply because they’ve fallen in price? It may indeed be naïve to sink more money into any one stock, because there’s every chance that the stock will fall and then keep on falling. But that’s never happened with the broad market. After every global stock market swoon, the overall market has always recovered and gone higher, even as many companies—and sometimes entire countries—are left behind.
Among strategists and money managers, it would no doubt be deemed more sophisticated to consider market valuations before buying the dip. But here’s the problem: If you’d avoided stocks because valuations were rich, you would likely have spent much—and perhaps all—of the past three decades sitting on the market’s sidelines, while the S&P 500-stock index soared almost 1,500%.
If valuations shouldn’t guide your buying, what should? If you’re sinking more money into a globally diversified stock portfolio, I don’t think there’s anything wrong with taking your cues from recent market action. If prices are down today, it’s probably a decent time to buy a little more of your total stock market index fund—and, if prices are down sharply, it’s likely a great time to do so.
No, price isn’t the same as value. But given that traditional valuation metrics don’t seem to tell us anything about short-term performance and relatively little about long-run returns, price may be the most reliable guide to value that we have—and falling prices may be as good a buy signal as we’re going to get.
I’ve always preferred to add to my stock funds on down days. Why wouldn’t I? And during big market downdrafts, including both 2007-09 and this year’s bear market, I moved hefty sums from bonds to stocks, while also scrounging up new savings to add to my stock portfolio. What if the market rally of recent months turns into another rapid retreat? You’ll find me buying yet again.
The Wall Street crowd may sniff at this knee-jerk reaction to market declines. But if we shouldn’t buy on dips, what’s the alternative? Buy on market rallies instead? Would that make more sense?
The truth is, belittling those who buy the dip is yet another instance of Wall Street’s ongoing and unjustified denigration of everyday investors. Wall Street’s hope: Investors will be bullied into paying up for the Street’s “sophisticated” investment services, which just happen to have a long and sorry history of market-lagging performance. Maybe all those “professionals” would post better results if they, too, bought on dips.
What they’d discover is that it takes mental fortitude. When stock prices fall, many investors—amateurs and professionals—are scared off. It requires a certain temperament, along with years of investment experience, to ignore the crowd and the prophets of doom. Want to make good money? Next time the broad market is worth less, do yourself a favor: Step up to the plate and buy more.
Follow Jonathan on Twitter @ClementsMoney and on Facebook. His most recent articles include Just Another Day, Almost Zero and My Four Goals.
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Interesting how you changed the articles that are presented on the site to hide some of contradictions in your messaging. It demonstrates an intellectual dishonestly that I didn’t expect from you. This article is prefect because it reveals your arrogance in predicting future market returns. The opposite of what this site was supposed to be about.
There’s no arrogance, no dishonesty and no contradiction — because I’m not suggesting folks predict market returns and never have. But I do suggest investors react constructively to what’s happened in the markets.
Good Article.
I am always fully invested, but if my AA deviates 5% or more from my target between equities and bonds, I sell the one that went up and buy the one that went down. It won’t optimize your returns, relative to market peaks & valleys, but it will boost them over time relative to pure buy and hold. Now you have me wanting to model the effect…
The problem isn’t buying the dip. It’s waiting to buy the dip, because most of the time the market goes up.
+1. Plus, it’s hard to actually pull the trigger when the market is down. Nobody wants to catch the falling knife and buy in just to see another 10 or 20% in losses… but nobody wants to have the market recover without having bought in.
LOVE the low road with a diversified, passive index-powered portfolio. 🙂
I never considered expanding the concept of unsystematic risk (normally individual company risk) to include countries as well. A tightly controlled political entity like Japan or China can certainly be regulated enough to behave like an individual company. Japan’s 30 year loss record appears no where near its end – it could easily become 40.
Great teaching point – thanks Jonathan! 🙂
Here’s what I don’t understand. In order to buy the dip, you need to have idle cash that you don’t need to touch for at least 5 – 10 years (if you need it sooner, it shouldn’t be in stocks). How are you accumulating this pile of idle cash and where are you keeping it? Is it better to keep the cash idle for an indeterminate period of time until there is some sort of dip or is it better to invest it in your recommended low-cost index funds as soon as the cash is available?
You could buy the dip by moving money from bonds to stocks or by digging deeper that month and saving more money. Deliberately accumulating cash to buy on dips would be market timing — which I don’t recommend.
I don’t think you have ever fully explained how you decide to change your target allocations from 60 to 95 and back.