Amidst market uptrends over the decade, many investors capitalized on Buy the Dip opportunities that arose due to short-term market uncertainty.
However, as the markets melted in 2022, it was time to address the elephant in the room. Is “buy the dip” a good strategy for the long term? Typically the answer is NO. Investors responding to short-term price movements is disparate from investing long-term.
Not an ideal approach. Why?
Here are some reasons –
1. Cash is Trash
Buying on the dip requires holding onto cash to buy with it. For long-term market gains, cash means losing out on potential returns. Additionally, inflation decreases your purchasing power day after day.
2. Dividends
A report from Hartford Funds in 2022 asserted that dividends constituted an average of 40% of total returns from 1930 to 2021. By sitting on cash, investors miss out on a fundamental source of growth.
3. Risk
Buying the dip in an attempt to time the market might be a risky approach. Occasionally, it could work in a lurching bull market. Though, if the market heads down for sustained periods, it can become an omen to your overall financial well-being.
4. Justified
At times, a stock price tumbles for good reasons. Like a change in the company’s fundamentals or a broader shift in industry/macro dynamics.
The way to go
The dollar-cost averaging, or investing a designated amount per month, is an ideal investing strategy when you have a steady income. Research shows that the cost of lingering for the perfect investment moment surpasses the benefit of ideal timing. A long-term disciplined investing based on a financial plan that considers your risk tolerance and investment return objectives is far less dicey than buying the dip.
In case you would still like to explore the opportunity of a future market downturn, review this checklist –
1. Impose a boundary
Setting a limit on uninvested cash, no more than 10% of investable assets in cash is a good thumb rule.
2. Risk Management
Make sure the portfolio is within the range of optimal risk and diversification when you buy on the dip. For instance, if you buy a particular stock on the dip, it should not increase your portfolio risk and stock/sector allocation beyond your thresholds.
3. Research
Any investor buying the dip needs to conduct proper research. Analyze the fundamentals to avoid going long on any stock that will only go down in the future. Also, watch out for any macro and industry-related headwinds.
4. Know your biases
Be conscious of psychological and emotional factors that may cloud your judgment. The keenness of “getting a bargain” should not affect the core tenets behind your objective decision-making process.
