“Buy the dip” is a phrase that has in some ways defined the four-year-old bull market. There have been some pretty big dips so far: The S&P 500 fell 16 per cent in 2010, 19 per cent in 2011 and nearly 10 per cent in 2012. The problem is that dips are essentially random events – impossible to predict the start of them and just as difficult to predict the end, making them a futile exercise in market-timing.
Well, that wasn't much of a dip, was it?
After the S&P 500 hit a record high recently, nudging above its 2007 peak and fully recovering from the financial crisis that followed, the benchmark index did a little wobbling.
As the losses accumulated to all of 1.3 per cent during the ensuing bout of turbulence, market watchers grew more confident that a dip was coming and investors salivated over the thought of slipping into the four-year-old bull market on the cheap.
The stock market had its own thoughts, though. The envisaged 5 to 10 per cent retreat didn't occur. Instead, the S&P 500 hit new highs within days. But at least the market action provided a powerful investing lesson: You can't predict dips.
"Buy the dip" is a phrase that has in some ways defined the four-year-old bull market. There have been some pretty big dips so far: The S&P 500 fell 16 per cent in 2010, 19 per cent in 2011 and nearly 10 per cent in 2012.
Each time, the index has fully recovered within a few months, providing investors with all the evidence they need that dips are gifts to anyone nursing some uninvested cash.
The problem is that dips are essentially random events – impossible to predict the start of them and just as difficult to predict the end, making them a futile exercise in market-timing.
Trying to time the start of a dip could easily leave an investor sitting on the sidelines, watching the gains pass them by. Consider that the S&P 500 has now risen some 15 per cent since November without so much as a 5 per cent setback. Even if a 10 per cent correction occurred tomorrow, these unfortunate sidelined investors would have still missed out on gains of about 5 per cent.
The waiting game can be far more painful. If you had been waiting for a dip of 10 per cent before entering the start of the bull market in 2009, you would have had to wait until April 2010 – at which point the S&P 500 had already recovered about 70 per cent.
At the same time, there is no law that states that all dips must be followed by impressive rebounds. The market downturn that began in 2007 consisted of a series of dips – each one taking the S&P 500 lower, until the index finally bottomed out in 2009 after shedding more than 50 per cent of its value. Buying those dips was a painful experience.
A far better strategy also happens to be remarkably simple: Rebalance your portfolio at regular intervals – say, once a year or quarterly.
If you maintain a consistent allocation toward equities, your rebalancing will force you to buy stocks after they have fallen in value and sell them after they have risen. That's not buying the dips and it makes no attempt to time the market – but it will probably serve you far better.
READERS: When do you know the market has reached to lowest point of a dip's trough? Is it worth taking a dip?
David Berman