I have historically been a proponent of buying the “dip.” That is, purchasing stock more often when the market is distressed. I found that some methods of buying the dip provide better returns than the more commonly recommended strategy of, “dollar cost averaging.” With dollar cost averaging investors buy stocks at predetermined intervals throughout the year, regardless of price, to get the best average price-per-share. However, now I am beginning to question both strategies. At least if I already have all the money that I want to invest up front.
Most attempts to buy the dip, or really any market timing strategies, fare worse than dollar-cost-averaged portfolios. The dip-buying strategies that do win are also difficult to maintain. Moreover, lump sum investing typically beats both strategies. So, let’s compare buying the dip, with dollar cost averaging and lump sum investing to determine which path makes the most sense for investors.
The Pros and Cons of Buying the Dip
Pros of “buying the dip”
- You don’t need a crystal ball to buy the dip
As we discussed in, How to Invest When the Stock Market Crashes, for broadly diversified mutual funds there are ways to confirm the price of a fund before you buy shares. For instance, if you have the fund VTSAX in your portfolio and only want to buy shares when the cost drops 2%, you can track VTI (ETF version tracking the same index) which trades throughout the day. If VTI loses 2% by the end of the day, so will VTSAX and the price for mutual fund orders made throughout the day, are locked in at the end of the day so you are guaranteed that share price.
Related: The Best Free Budgeting and Net Worth Tracking Spreadsheet - If you are a short term investor with lot of cash to deploy, buying the dip may provide an ideal entry to the market
During times when stocks appear to be overvalued and there is strong evidence for an upcoming price drop (i.e. a global pandemic), it may be best to wait a short amount of time for a correction. - You can beat dollar cost averaging by following some guidelines
Many have pointed out that buying the dip can’t compete with dollar cost averaging because dip buyers invest later (or not at all) and make fewer investments overall. As time passes, their data shows, the chances of beating dollar cost averaging continue to decrease. However, the dip buying strategies provided are usually rigid examples. If you only buy stock when the market decreases 5% and the market never decreases by 5%, the strategy would keep you out of the market altogether, which is never good.
Related: This Is Why Being Debt-Free Is Overrated: The Math Behind Opportunity Cost
However, if you were to incorporate a more flexible strategy (albeit more time-consuming one) you actually can beat dollar cost averaging. This is especially true in years when the value of stocks are rapidly falling.
Let’s take a look at how a more flexible approach to buying the dip changes the results.
Buying the dip versus dollar cost averaging – 5 Years of Data
Though 5 years is not the greatest sample size, the last 5 years of stock market activity have provided enough fluctuation to demonstrate the merits of “flexible” dip buying. I compared dollar cost averaging to flexible dip buying with VTSAX (total stock market) between 2017- 2021, to see which strategy would give investors the best overall price-per-share. I haven’t yet looked at the total return from each strategy, however flexible dip buying should provide a better return in the long run because it allows for quicker investing during market crashes and roughly matches dollar cost averaging during bull markets.
Here are the guidelines:
Dollar Cost Averaging:
- The total annual contribution is $6,000.00.
- The investor buys stock at the beginning of each month* in $500 increments.
Buying the dip
- The total annual contribution is $6,000.00.
- The investor must buy stock in $500 increments when the price has decreased 2% or greater from the previous day.
- The investor must make a purchase at the end of every month* if there is no decrease of 2% or more.
* Dollar cost averaging starting at the beginning of each month, as opposed to the end of the month (as with flexing dip buying) helps its result a little in bull markets. That’s because investments are made thirty days earlier and in a bull market the prices are generally always rising. Flexible dip buying forces you to wait for a 2%+ drop, or else buy shares at the end of the month, typically at a slightly higher price point. However, in years where the market is crashing, this flexible dip buying strategy allows for quicker investing at lower price points since there are more 2%+ drops in succession.
The Results:
From the results for each year below we can see that during years with less fluctuation, like in 2017, it’s basically a coin flip. However, in years with more market volatility (2020), the benefits of buying the dip become clearer, as this strategy provides a lower price-per share while investing contributions faster.
2017
Dollar cost averaging:
Total shares purchased: 98.56
Average price per share: 60.88
Buying the dip:
Total shares purchased: 97.49
Average price per share: 61.55
2018
Dollar cost averaging:
Total shares purchased: 87.14
Average price per share: 68.85
Buying the dip:
Total shares purchased: 88.35
Average price per share: 67.91
2019
Dollar cost averaging:
Total shares purchased: 84.29
Average price per share: 71.18
Buying the dip:
Total shares purchased: 84.87
Average price per share: 70.69
2020
Dollar cost averaging:
Total shares purchased: 77.18
Average price per share: 77.74
Buying the dip:
Total shares purchased: 90.69
Average price per share: 66.16
2021
Dollar cost averaging:
Total shares purchased: 56.79
Average price per share: 105.66
Buying the dip:
Total shares purchased: 56.05
Average price per share: 107.05
5 Year Summary
Dollar cost averaging:
Total contributions: $30,000
Total shares received: 403.95
Average price per share: $74.27
Buying the dip:
Total contributions: $30,000
Total shares received: 417.45
Average price per share: $71.86
Excel (link) data used*
Though these results are not definitive, they do demonstrate pathways that buying the dip can beat dollar cost averaging. To further test and potentially improve this strategy, an investor could double their investment during 2%+ percent drops, while making the normal investment in months where no drop occurs.
Cons of “buying the dip”
- Buying the dip is much more time consuming than dollar cost averaging
From the data above we can see the dedication that goes into flexible dip buying. It requires tracking the price of funds daily so that you can buy shares when their prices drop. Dollar cost averaging is much more simple, leaves less room for error and demands less discipline. - Certain strategies can keep you from investing during bull markets
If you incorporate one of the aforementioned dip buying strategies wherein you only invest during significant corrections, you will make far fewer purchases throughout the year and likely not keep pace with dollar cost averaging.
- To incorporate flexible dip buying you need to have your full contribution “up front”
Because with the flexible buy the dip strategy you are essentially dollar cost averaging until a market correction, at which point your purchasing accelerates, you will need more cash on hand to incorporate this strategy. With dollar cost averaging you only need the amount of your monthly contribution. - You will likely do better by just entering the market as soon as possible, regardless of current share price
The biggest problem with all buying the dip strategies is that you have cash on hand that is not immediately being invested. Most of the time, time in the market is better than market timing.
The Pros and Cons of Dollar Cost Averaging
Pros
- Dollar cost averaging takes emotion out of investing
If you automate your investments, with dollar cost averaging you don’t even need to look at your portfolio or market news. Nor should you, stock market news is bad for long term investors. - Dollar cost averaging is much less complicated and less time consuming than buying the dip
As I have said before, time is our most valuable resource and not everyone has the time, stamina or discipline to check market prices daily, or stick to a complicated strategy. - Dollar cost averaging beats many dip buying strategies over time
If a dip buying strategy dictates waiting for a certain drop in price before investing, it’s nearly impossible to keep pace with dollar cost averaging or lump sum investing.
Cons
- Buying indiscriminately can cause you to to enter the market at a high point
For short-term investors with a lot of cash to deploy, it makes sense to enter it into the market as fast as possible. Spreading out the investment may help mitigate loss but does so at the cost of significant returns. - Long term investors will likely earn more by entering the market as soon as possible, regardless of current share price
The Pros and Cons of Lump-Sum Investing
Pros
- Time in the market beats market timing
One Vanguard study which spanned from 1926 through 2011, over three international markets, showed that lump sum investing beats dollar cost averaging about two thirds of the time. It makes sense that lump sum investments give you an edge over dollar cost averaging and (probably) buying the dip because over time, the power of compounding returns is far more important than current price point. And over enough time, lump sum investments experience some of the benefits of dollar cost averaging anyways, as they are averaged over the decades they are held.
In the United States, 12-month DCA led to an average ending portfolio value [over 10 years] of… 2.3% more. The results were similar in the United Kingdom and Australia.
Vanguard (Dollar-cost averaging just means taking risk later)
Cons
- You need to have the full amount of your contribution the beginning of the year
- If your primary concern is shielding yourself from losses, dollar cost averaging results in fewer losses in a down market
- If you make a significant investment before a prolonged bear market, it could change your investment horizon or cause you to sell at a loss
Summary:
Comparing dollar cost averaging with buying the dip and lump sum investing helped me realize some of the assumptions I was making with my investments. I have been overly concerned with the share price and have kept too much cash on hand hoping to buy shares during a crash. As a long term investor I have also spent too much time trying to beat dollar cost averaging when I would likely get a better return by investing in lump sums and never looking at stock market news again. There are good reasons for employing each strategies but personally, I will be lump sum investing in order to simplify my life and experience the best return on my retirement investments as possible.