Is buying the dip a good investment strategy for you?
One thing you’ll notice the more you invest is that downturns in the market are inevitable. No bull market lasts forever, just like no bear market. The better you understand this, the easier it will be for you to ignore short-term price movements in the market and focus on your long-term goals. It’s much easier to do this during bull markets when you see your portfolio going up, rather than during bear markets when your portfolio seems to be falling day by day.
Another thing you will notice during these down times is that investors encourage each other to buy the downside, which basically means buying stocks after prices have dropped significantly. If you’re wondering if buying the dip is a good investment strategy for you, chances are the answer is yes.
It can be like discount shopping
Buying the dip is a good strategy, but it should only be part of your larger investing plan, not the whole strategy itself. Your primary focus should be the long term, but that doesn’t mean you can’t take advantage of short-term moves to move closer to your long-term goals. As stock prices fall, buying the dip gives you the opportunity to pick up some of your favorite stocks at a discount.
Let’s look at the market crash that happened in early 2020 as the pandemic started to gain momentum, for example. On February 14, 2020, the Vanguard S&P 500 ETF (VOO -0.26%) was at $310.28. As of March 20, 2022, the fund had fallen to $210.74. If you were an investor in the fund, instead of panicking and selling your shares, you could have seen this as an opportunity and bought the dip, thereby increasing your stake. Even if you hadn’t caught the fund at $210 and bought it for around $250, those stocks would still be up over 40% since then, even after falling over 20% since July 13, 2022. .
Buying the drop gives you a chance to lower your base cost, which is the average amount you paid per share of a specific stock. For example, if you bought 100 shares at $20 and 100 shares at $40, your cost base would be $30. Your cost basis is important because it determines how much you gain (or lose) when you decide to sell your shares.
Don’t try to time the market
When considering buying the dip, you want to avoid trying to figure out where the stock is going to bottom, which is much easier said than done. Why would you buy stocks today at one price if you can get them later at a cheaper price, right?
The problem is, you never want to find yourself in a situation where you’re trying to time the market. Not only is the stock market volatile and prices could suddenly rise as you anticipated them to fall, but even if you get it right this time around, it’s nigh on impossible to time the market consistently over the long haul.
Instead, you should feel comfortable investing in the present at the given price or using cost averaging to make consistent investments over time. With dollar cost averaging, you may find that you are buying stocks at a lower price at some times and at a higher price at other times; that’s how it goes. What’s important is that you stay consistent and don’t try to time the market.
stefon walters has positions in Vanguard S&P 500 ETF. The Motley Fool has positions and recommends Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy.