Some investors clutch their hearts when the stock market dives. Others see an opportunity to dive in and “buy the dip.”
You may be wondering what it means to “buy the dip.”
Investopedia, my go-to site for good investor information, explains the investment strategy this way: “ ‘Buy the dips’ means purchasing an asset after it has dropped in price. The belief here is that the new lower price represents a bargain as the ‘dip’ is only a short-term blip and the asset, with time, is likely to bounce back and increase in value.”
To put it another way, for those of you who were born to bargain-shop, this means stuff is on sale.
Market dips in 2020, courtesy of a global pandemic that made stocks cheaper to buy, have resulted in a spike in first-time investors, according to a report earlier this year by the FINRA Investor Education Foundation and NORC at the University of Chicago.
During 2020, there was a surge in retail investors who opened taxable, non-retirement investment accounts via online brokers. These new investors were younger, had lower incomes, and were more racially diverse, the report found.
One reason new investors opened accounts was that dips in the market made stocks cheaper to buy.
Dan Egan, director of behavioral finance and investing at the online investment firm Betterment, said he understands why people gravitate to a “buy the dip” strategy. Psychologically, it can get people off the investing sidelines.
“It does give you this sense of confidence of, ‘Well, at least I didn’t buy at the top,’” Egan said. “It’s a way of minimizing regret and feeling comfortable with getting invested at a specific point in time.”
The stock market can be scary, and buying when stocks are down, from a behavioral point of view, can help people get invested and benefit from growth in the market, Egan said.
But Egan and Callie Cox, a senior investment strategist with Ally Invest, warn about being overly confident about this strategy.
“When the stock market is going through a sell-off, you may not be able to buy the dip, because of your emotions,” Cox said. “Buy the dip is one of those things that works really well on paper, but it doesn’t work well in real life. It’s something that I personally struggle with because as an investor, I want to buy the dip, but I’m human and sometimes I don’t feel good when the market’s going down. Buy the dip is market timing.”
Buying on dips doesn’t necessarily guarantee better returns, they said. While you wait for a downturn, you could be missing out on significant upturns in the stock market.
“The issue with buying the dip as a strategy is that you can end up sitting out of the market for those long periods of time when it rallies,” Egan said.
It’s also impossible to know when the market will dip to its lowest point during a particular period, leaving many people waiting for the right time to buy. You could be waiting a long time.
Then there’s the question of how low is low enough?
“Obviously, if you buy at a 1 percent dip, that’s not going to be dramatically different than just buying whenever you put the money in because 1 percent dips happen pretty frequently,” Egan said. “At the far opposite end, there is this ‘buy if the market drops 50 percent from all-time highs.’ You’re going to very rarely invest if that’s the case because the market doesn’t drop that dramatically that often.”
In a market report last September, Cox advocated for dollar-cost averaging. This is a strategy in which you automate the process by investing the same amount of money on a regular basis regardless of the stock price.
“The world tends to frame investing as an all-or-nothing pursuit,” Cox writes. “You’re either all in and bullish, or on the sidelines with no skin in the game. But in reality, many people tend to gradually put their money in the market based on the calendar, instead of trying to guess the next top or bottom. That’s a strategy called dollar-cost averaging, and it rewards consistency over timing.”
Besides, using dollar-cost averaging, you’ll eventually be buying during dips.
“Dollar-cost averaging works really well because, if you’re investing a fixed amount of money at different times, you naturally buy fewer shares when the share price is high and then more shares when the share price is low, so you get a little more exposure to those dips when they happen,” Cox said.
I like Charles Schwab’s caution about market timing, “Our research shows that the cost of waiting for the perfect moment to invest typically exceeds the benefit of even perfect timing.”
In other words, don’t let your efforts to beat the market lead you to sit out too long.