Why “Buy the Dip” Is Easier Said than Done
Is There a Strategy Better than “Buy the Dip?”
It’s my understanding that income investors tend to be more value-conscious than growth investors. The reason is simple: at any level of cash payout, a company’s dividend yield moves inversely to its stock price. So, if a stock has bloated valuations, chances are it doesn’t offer much in the form of yield.
And that implies the “buy the dip” strategy could be worth considering—particularly when it comes to blue-chip dividend stocks. If you’re willing to hold a company’s shares in the long run, buying on pullbacks might result in lower average costs than buying when the stock is shooting up.
However, while we all want to buy the dip, the strategy is easier said than done.
First, in order to buy the dip, you have to follow the market very closely, which kind of goes against the point of income investing. For someone whose goal is to collect passive income from a dividend portfolio, watching the market ups and downs is probably not their favorite pastime. Besides, following the market closely also means watching your portfolio’s value fluctuate with it, which can cause some stress when things are in the red.
Second, when there’s a dip in stock prices, many people simply can’t pull the trigger. And I’m not talking about a bear market—or even a correction phase.
Just take a look at the last trading week of January. On January 25, the S&P 500 opened at 3851.68. On January 29, the benchmark index closed at 3714.24. That was a drop of about 3.6%—not much in the grand scheme of things, especially since the index was still well above last year’s September to October consolidation range. But if you were following the financial media, you’d get the impression that things were about to fall off a cliff.
Granted, the media likes to hype things up, and few things are better at getting the audience’s attention than fear. But the reality is, when the market is dropping and you see a sea of red in your portfolio or watch list, it’s not easy to place that “buy” order.
And then there’s the possibility that the dip doesn’t happen quick enough. Sure, stocks swing in both directions all the time. But when a company with strong fundamentals is traveling on an uptrend, it may not experience a big enough dip until it reaches a much higher price level. This can also happen when a stock is breaking out of its previous trading range. Yes, there will be a consolidation period eventually, but it may occur at a further-away price point.
Instead of waiting to buy the dip, some investors have been using a strategy called dollar-cost averaging, which is to invest equal amounts of money into a stock at regular intervals. Therefore, when the stock becomes more expensive, the fixed amount of money buys fewer shares. When the stock gets cheaper, the same amount of money buys more shares. The strategy does not aim to buy the dip, but it automatically buys more shares at a dip and fewer shares at a spike.
Dollar-cost averaging is great for people who are just starting to save for retirement. They don’t need a big pile of money to begin with, and they can simply take out a portion of each paycheck and invest it in solid dividend-paying stocks. With discipline, the dollar-cost averaging approach can help build a substantial position in dividend stocks over time.
Now, I should point out that, while you don’t have to buy the dip, you’ll need the ability to hold through dips if you have a long enough investment horizon.
Of course, I’m talking about stocks with strong enough fundamentals that you’ll want to invest in them for the long term. But even the most solid blue-chip names with decades of dividend growth track records can plunge during a market downturn. Remember last March? It was quite difficult to be a buyer when the bottom seemed to be falling out.
If you don’t buy the dip, you should at least avoid panic selling. Investors who sell at the bottom will miss out on the massive rally that follows. On the other hand, investors who use dollar-cost averaging will add more shares—at a substantial discount—during a bear market.
Furthermore, remember that a man by the name of Warren Buffett once said, “The stock market is a device for transferring money from the impatient to the patient.”