When the market is tanking, the bulls like to remind investors to "buy on the dips." But this strategy doesn't work as well as logic might suggest. Sure, it makes intuitive sense. The whole point of investing, after all, is to buy low and sell high. When prices take a sudden drop, the market gives you an immediate opportunity to buy low. Why not take it?..More at the link.
Start with trying to define it. What is a "dip"? Is it a 2% decline in the value of a market index, or 5% or even more? Does a dip occur in a day, a week or longer? Because investors appear to go by gut instinct—if the market goes down enough to feel scary, that is a "dip"—the lack of a consistent definition makes it hard to determine whether buying on the dips is effective...
To see how buying the dips may work in practice, I asked William Bernstein, an investment manager at Efficient Frontier Advisors in Eastford, Conn., to look back over the past 10 years using the Vanguard 500 Index Fund, a common proxy for the U.S. stock market as a whole because it tracks the S&P 500 market average.
Had you bought the fund exactly 10 years ago, you would have paid $77.22 (adjusted for dividends). If you had bought every time the S&P 500 index closed down 2% in a day, you would have been able to capture 137 such dips—but your average purchase price on these days would have been $82.82. If you defined a dip as a 5% daily drop, you would have gotten 13 opportunities to buy "on the cheap"—but even those more drastic dips averaged out to a purchase price of $78.39. Again, you ended up paying more to buy on the dips than you did to get on board in the first place.
"It's very counterintuitive," Mr. Bernstein says. But a lump-sum investment at the beginning would have earned you an annual average total return of 3%. Buying on the 5% dips would have reduced your return by 0.1 percentage points annually, and buying on the 2% dips would have cut your gains by an annual average of 0.8%, he estimates...
Another issue: Buying low doesn't do you much good unless you also can sell high.
24 September 2011
Re "buying on the dips"
Some objective data on that advice, courtesy of the Wall Street Journal: