Difficulties with making "buying the dip" work
I've been hearing a lot lately from people who are very keen to build a diversified, high quality stock portfolio but who are concerned about the level of stock prices and are content to wait to "buy the dip". While that theory sounds great in practice, it doesn't always work out well.
With prices on many stocks having risen strongly through 2020, its a little difficult to find many very attractive "bargains". However bargains need to be put in context of the level of interest rates that are prevailing at the moment.
It's natural to want to sit and wait it out on the sidelines, looking for better prices. However trying to wait out declines and buy the elusive dip in stock prices, if and when it occurs, isn't always a strategy that's guaranteed to work. While it sounds great in theory, there are a few pitfalls with executing this in practice.
The thing that I love about regular accumulation is that I know how much I am spending each and every quarter, and the money gets planned, budgeted and spent. Its a cycle that repeats itself each and every quarter. I really don't have the discipline to build up a massive cash pile, watch it wither away at a negative real returns, and then refrain from tapping into it for general day to day needs. And even if I do have the discipline to stash the cash and just sit around and wait.... what's to say my circumstances won't change in the interim? A desire to buy a new car or take that holiday becomes easier to fulfill because of that cash growing in the bank. And that's even putting aside potential issues of changes in job situation, or relocation. To avoid these temptations, I find that its regular, scheduled investing works best for me. Like clockwork.
Getting Over the Fear Factor
If stocks plunge, and I mean really plunge, its going to be hard to overcome the natural tendency to want to flee. The recent plunge in growth businesses, where stocks dropped 30% plus played on the minds of many retail investors.
Really sharp downturns, which bring really good value, tend to be very scary events. So even if you set aside capital to buy the dip in theory at reduced prices, its going to mean getting over the fear factor of seeing portfolio values slashed, and then putting your hand up for potentially more pain. For really deep value like was seen in early 2020 or 2009, chances are that there are some scary macro events going on. Unemployment, debt crisis, coronavirus crisis which may end up having a real impact on your own personal economic situation and prevent you acting at the times when you had otherwise planned to.
Buying Too Quick, Too Soon
Assuming that you do summon up the conviction to buy during sharp downturns, you run the risk of buying too quick too soon, and not extracting maximum value. I've been a victim of this multiple times in the past. BP in 2010 was the classic example. I thought I saw good value, and I went in, too hard too soon as it turned out. BP kept falling and falling, but I was constrained in terms of how much more I could buy. I racked up a large exposure, and I couldn't continue to buy at the real low points. It's always easy to underestimate how long downturns last. Pacing yourself is key, however it can be really know how best to do that because all downturns are different.
The other very interesting thing about general market downturns is that in addition to lasting longer than you think, the path down and the path back up can also be more extended in duration. So instead of getting one opportunity to buy, there will likely be a bunch of opportunities to pick up stocks slowly and steadily, all at good value. By pacing steadily, you don't risk going too hard too soon, but pacing yourself and picking up the best values along the way while also making your capital go longer during declines.
I have observed that when downturns occur, either in the general market or in particular stocks, that it becomes a natural tendency to go out and accumulate the best values. Typically, that can lead to lopsided portfolios, where you go ahead and accumulate big on a couple of key names. That's not a good risk mitigation strategy, it leads to too much stock specific risk and concentration in key names. Its dangerous to plan for a future by assuming that no company is immune to failure. In contrast, through regular broad based accumulation on a monthly schedule, market downturns allow can allow one to pick up a number of names in one go, at great value. This enables the benefit of low prices, while also maintaining risk diversification.
Holding out and waiting for great market entry points can be a great strategy to build up wealth and income. The key is to ensure that one has the discipline to stash the cash and not do anything with it in the interim. Once opportunities arise, its important to not run too hard too fast, but to realize that even better values may emerge over time, so buying on specific levels of decline (ie 10%, 15% ) can be very helpful. Trying to ensure portfolio balance when opportunities present themselves is the final critical piece of the puzzle. For those that don't feel they have the discipline and ability to master all these things, regular accumulation in a set of high quality names is a great strategy in the interim.