Investors think they are smart when they really aren’t. In fact, many investors don’t even earn the return they think they do. They end up earning much less. One common practice I see when it comes to investing is buying on the dips. What exactly is buying on the dips?
It works like this. The stock market has a decent run up for a few months. As a result of the gains, some investors want to take money off of the table. In other words, they want to lock in their gains and sell some of their holdings. This causes stocks to drop in price.
Other investors, looking to make some more money, wait for this decline to buy more shares at a lower price. Hence the term, buying on the dips. They wait on the sideline until stock prices drop and then swoop in when they do decline. The question is does this strategy work?
Buying On The Dips: A Recipe For Failure
While we think that buying on the dips is a smart move to make, research shows that it really isn’t all that it is cracked up to be. First off, as humans, we tend to look at the short-term as opposed to the long-term.
By this I mean that if a stock was trading at $100 and dropped to $80, we buy because we think the stock is undervalued. After all, it was just trading at $100. We think $80 is a steal.
The problem with this is that most investors invest based on fear and greed. Just because the stock was trading at $100 per share doesn’t mean it is worth $100 per share. In other words, greed may have pushed the stock price higher than what the true value of the company was even worth.
This happens in the stock market all of the time. Look at the dot com era as an example. Cisco was trading as high as $80 per share at the height of the bubble. It’s been 17 years since and its current price of $40 per share is the highest it has gotten.
A Case Study To Remember
Back in 2011, Samuel Lee of Morningstar ran a simulation that dated back to 1926. In his study, he looked at stocks over three month periods. If the stocks were down, he bought. If they were up, he waited until there was another three month decline and then bought.
Since the long-term trend of the stock market is positive, this should have worked out in his favor. It didn’t.
It turns out that using this strategy produced a return of 2.9% worse than had he simply used a buy and hold strategy.
What does this tell us? It tells us that the stock market is efficient. It is very hard for an individual investor to exploit the market. As a result of this, I ask, why even try? Why try for the home run?
You aren’t trying to win a game when it comes to investing, you are simply trying to earn a decent return. What the market returns is a decent return.
The Simple Way To Win At Investing
You now know that a passive approach to investing is the way to go. But how do you implement this strategy to work for you?
For most investors, going with a robo-advisor is your best solution. This is because all you have to do is open an account and set up a recurring monthly investment. The robo-advisor will take care of everything else for you.
And since they use low cost exchange traded funds to mimic the market, you will always be earning roughly what the market earns.
If you want to get started with a robo-advisor, I have 2 for you to pick from. After researching the now crowded field, I’ve narrowed the list to these 2 that I think give you the best value for your money.
The other option is Wealthsimple. They are new to the scene but offer the same features as Betterment. But I like that they allow you to invest for free until your balance reaches $5,000. Click here to learn more.
If you want to be a successful investor and grow your wealth, you have to let compounding and time work their magic for you. Chasing returns and timing the market, neither of these works. If they did, everyone would be doing it. But the smart investors are the ones that are buying and holding over the long-term. You need to develop a similar mindset.
Create a long-term plan for your investing and then follow that strategy by using the practice that works, buying and holding for the long term.
Hi, my name is Jon and I run Compounding Pennies. I’ve been interested in personal finance since high school and love writing and talking about it. You can learn more about me in the Authors section of this site.