Should You Buy the Dips?
Market retreats & corrections may herald opportunities.
Provided by Andrei Jigalin
When stocks retreat, should you pick up some shares? If you like to buy and hold, it may turn out to be a great move.
Buying during a downturn or a correction may seem foolish to many, but if major indexes sink and investors lose their appetite for risk, you may find excellent opportunities to purchase shares of quality firms.
Remember what Warren Buffett said back in 2008: “A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful.” Even in that terrible bear market, savvy investors like Buffett sensed an eventual upside.1
Great stocks could be available at a discount. Corrections and downturns are part of the natural cycle of the equities markets. Wall Street has seen 20 corrections (10% or greater declines in the S&P 500) in the last 70 years, and stocks have weathered all of them.2
A comeback can occur not long after a correction: as S&P Capital IQ chief stock strategist Sam Stovall reminded Kiplinger’s Personal Finance, it usually takes about four months for the market to get back to where it was.2
After a market descent, there is ultimately a point of capitulation – a turning point when investors start buying again. Prior to that moment, you may find some good deals. Why not make a list of stocks you would buy at the right price, and perhaps define that price?
Some downturns & corrections go under the radar. Particular sectors of the market may dip 5%, 10% or more without much fanfare, because the focus is constantly on the movement of the big benchmarks. You might want to keep an eye on a particular slice of the market that has turned sour – it could turn sweet again, and sooner than bears think.
Don’t let the gloom dissuade you. Remember 2008? Stocks were supposedly down for the count. You had people who believed the Dow would fall below 5,000 and stay there. They were wrong. Seasoned investors like Buffett knew that measures would be taken to repair the economy, restore confidence and right the markets.
As he noted in an October 2008 New York Times op-ed piece, “To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions. But fears regarding the long-term prosperity of the nation’s many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now.”1
Since the end of World War II, Wall Street has experienced 13 bear markets and 20 corrections. Even so, large-company stocks have returned an average of 11.1% per year since 1945.2
Decline thresholds may be useful. If you practice dollar-cost averaging (i.e., you invest a set amount of money each month in your retirement account), you know that your money will end up buying more shares when prices are lower and fewer when they are higher. You can lift this strategy and apply it in a market dip or downturn. Instead of investing a set amount of funds per time period, you invest a set amount of funds at a decline threshold. So if the balance of your retirement account falls 5%, you put a set amount of funds in. If shares of a particular company fall 5%, you use a set amount of funds to acquire more of them.
Some people don’t like the buy-and-hold approach and would contend that tactical asset allocation has the potential to work just as well or better in a downturn. Whether you like to buy and hold or not, the chance to buy low is not easily dismissed. No one is guaranteeing you will sell high, of course – but you might find bargains amid all the bears.
Think about taking the opportunity to add to your portfolio if the market pulls back. A market drop may be your cue to buy shares of quality companies at a cheaper price.