Should You Buy the Dip?

- Philip, our savings is gone!

Look!

- Yeah, I know.

I put it in the stock market.

- Now?

While the market's tanking?

What were you thinking?

- You told me to.

- No, I didn't.

- Yeah, you did.

You texted me yesterday, "Don't forget to buy the dip."

- I meant the onion dip for the party this weekend.

- Oh.

- (sighs) I hope you at least bought some blue chips.

- Of course I did.

(bag crinkles) - Well, that's corny.

(upbeat music) Whenever the market is down, you'll hear a chorus of voices saying you should "Buy the dip."

But what does that mean exactly?

- Put simply, buying the dip means investing money into the stock market when share prices have recently fallen.

Since the shares are essentially on sale, you get more bang for your buck, or so the thinking goes.

When the market rises again, you'll get a higher return on your investment.

If the goal of every stock trader is to buy low and sell high, then buying the dip makes total sense.

- Imagine, for instance, that this is the last 12 months of a blue chip stock price.

If you get it- - Oh, blue chip!

- (sighs) If you manage to buy, say, $1,000 worth of stock at this point, you would've almost doubled your money in less than a year.

- But, of course, nothing looks easier in hindsight than stock trading.

The hard part is knowing when a stock has hit its lowest point.

If you had bought it just a bit earlier, you wouldn't be making nearly as much.

And if you waited just a bit longer, you would've missed your chance completely.

- And that's just the beginning of the dangers.

Buying the dip relies on a statistical principle called regression towards the mean.

It says that ups and downs are basically temporary, and they will all average out to reflect a stable statistical trend.

Traders who buy the dip are assuming that if a stock price falls sharply, it will most likely go back up again.

- And that is the case much of the time, especially when fluctuations are based on investor emotional trends.

But sometimes, a fall in stock price is indicative of a fundamental problem in the company or sector.

Maybe a company is poorly run and the stock price deserves to crash.

Instead of buying the dip, you may find yourself tumbling down a cliff with no bottom in sight.

- Despite these risks, you still might be interested in buying the dip.

So, how should you go about it?

Most investors who attempt it will set some portion of their investment dollars aside in cash, waiting for a stock to fall from a recent peak by a certain percentage, say between 10 and 50%.

Both ends of this spectrum carry risk.

If you set the percentage too low, you may buy in well before a stock has hit its bottom.

But set it too high, and you may be waiting around forever.

- For example, Ted here has about $20,000 to invest, but he wants to buy the dip.

So he keeps $3,000 in cash and waits for one of his favorite stocks to fall by 20%.

Finally, after 12 months, it happens.

And Ted picks up 20% more shares than his money would've bought the week before.

The stock falls a little lower.

Eek!

But then starts regressing toward the mean, even surpassing its recent high.

Well done, Ted!

You beat the system.

- Or, did he?

Ted may have bought the stock at a relatively low price.

But when you look a little further back in time, it doesn't seem like such a win.

This stock, like many, has a fairly consistent upward trend.

He bought the stock for less than it cost a week ago, but more than it cost 12 months ago.

If Ted had just gotten all of his money in at the beginning, he'd have done better overall.

- Ted failed to factor in the opportunity cost of waiting to buy the dip.

Most financial advisors will recommend that if you have money to invest, invest it now.

Cash that just sits around is worse than wasted potential, it's actually losing value thanks to inflation.

- There is, however, another investment method that confers some of the benefits of buying the dip without all of the risks.

It's called dollar-cost averaging.

It's actually really simple.

You just commit to putting the same percentage of your paycheck into the stock market every month, regardless of whether it's up or down.

- So for instance, let's say that Marisol here decides to put $200 a month into her favorite stocks, no matter the price.

That means that when the share price is inflated, she'll buy less of them.

And when the share price is low, she'll buy more.

It's an automatic way of making sure you're paying what the stock is really worth historically.

And for the vast majority of investors, it has a much better track record than trying to buy the dip.

- Don't get us wrong.

Some people have had great success in buying the dip.

And if you've been waiting for the right time to start investing, it's not a bad idea to get in when shares are cheap.

- But just like a gambler who occasionally hits the jackpot, most people who make a habit of it will eventually come out behind.

Study after study has concluded that accurately timing the market is virtually impossible.

- Disciplined investors who think long-term and don't try to beat the system almost always perform better.