On its face the strategy of “buying the dip” seems much more measured than merely trying to identify low-cost stocks that are destined to become the next Apple. But it’s still a risky strategy.
Just like it sounds, to buy the dip is to purchase stocks that are temporarily undervalued. For example, Pitney Bowes, Paypal, and Meta (formerly Facebook) are all well-known, category-leading companies whose share prices have recently experienced a significant decline. Buying the dip would mean purchasing them at a discount (their current low price compared to recent higher prices) and enjoying the returns when they rise back to their previous values.
But the investor in this scenario is making a huge assumption. The word “dip” means a temporary depression. You go down a little and then go right back up. The market, however, is under no obligation to return a single dropping stock to its “normal” level, no matter how prominent the company might be.
Of course, stocks go down and back up all the time. But there’s no way of knowing if a drop in value is the beginning of a dip or the start of a long slide. A good example of this is GE (General Electric), whose long-term share decline fooled many forecasters.
Matt Krantz, writing for Investor.com, cites a more recent example of investors getting burned when they thought they were buying the dip. The late January decline of the S&P 500prompted many bargain hunters to scoop up prominent individual stocks at what they thought was a discount.
Investors Business Daily analyzed data on eight stocks that quite a few thought were in a temporary decline. These companies, representing sectors as varied as tech, healthcare, and industrial services, were each off by more than 10%, luring in would-be dip buyers. But instead of returning to their “expected” value, these stocks plunged an additional 10% or more and have yet to recover.
While in the long run, stocks historically have tended to increase in price, dip investors that are looking for short-term gains in a handful of individual companies are likely to have taken their recent losses and moved on.
The prudent investor will stay committed to a long-term strategy that doesn’t rely on correctly timing short-term opportunities. Instead, they’ll own a broadly diverse portfolio of stocks and bonds that is consistently rebalanced back to original targets regardless of current market gyrations. This strategy helps lower the risk of individual stock concentration and tends to smooth out risk and return over time.
Of course, systematically contributing to your portfolio means you will occasionally be buying the dip—investing in some instruments that can eventually prove to be bargains. But because you won’t know which stocks are winners until well after the fact, staying disciplined about your strategy for an investing lifetime makes the most mathematical sense.
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