We humans always want to buy things cheaper, it doesn’t matter if that thing is already on discount, we still want to pay a little less.
And nowhere this is more evident than investing. We always want to time the markets, get in at lowest prices and try to increase the returns. But this is not a prudent way to invest. Specially in bull runs like one we are witnessing now. Surely we have all be waiting for the correction, only to see markets move higher and higher
Nothing about investing is surefire, we are dealing with the unknown. It might be a bad idea to hold off on investing right now if you have the money. For example, imagine deciding not to buy until there is a 20% dip in the market. Now imagine that the market doubles without any such dip. Even if the market were to immediately dip 20%, prices would still be 60% above where they were when you started investing. Therefore, when you buy the dip, you end up buying not at a 20% discount, but at a 60% premium.
Came across a study from Fidelity that shows people who try to time the market risk missing out on the best days for growth.
The above study is only until March 2020, given how the markets have behaved over the last year had one waited for correction to time the entry, imagine the returns one would have missed out on.
According to a report on Sensex, from 1979 to 2017:
During the 38 years, Sensex went up by 251x
If you would have missed 7% of the best months, your returns would have been ZERO.
If you would have missed 1% of the best days, your returns would have been ZERO.
Though contrary to this:
If you missed 10 (2%) of the worst months, your returns would have been 1600x
If you missed 5 (1%) worst months, your returns would have been 760x
If you missed 1% of the worst days, your returns would have been 56,800x
A startling number for sure but here’s an interesting article that dives deep into buying on dips approach. This compares two investing models Dollar Cost Average (DCA) where you invest a fixed amount each month and Buy the Dip, wherein you invest only when the market dips a certain % from its peak.
It shows that the Buy the Dip strategy outperforms DCA in shorter-term, but in the longer horizon, it’s not much better than DCA:
This chart shows that there is roughly a one in four chance of beating DCA when using a Buy the Dip strategy with a 10%-20% dip threshold. If you were to use a 50% dip threshold, the chance of outperforming DCA increases to nearly 40%. But this doesn’t come without a cost. Because while you are more likely to outperform DCA when using a bigger dip threshold, you also underperform by more (on average) as well.
The reason why Buy the Dip usually fails is simply because market dips, especially larger dips, are rare. Without dips to buy, Buy the Dip is just an 100% cash strategy, which is a terrible way to invest for the long term. More importantly, while large dips can generate larger returns, predicting them beforehand is near impossible. So be careful before waiting for one because your portfolio is likely to miss out.
There’s a nice quote from Warren Buffett:
“You only have to do very few things right in your life so long as you don’t do too many things wrong.”
To long-term investor volatility in markets is short-term noise, that shouldn’t heavily influence investment decisions.