If you’ve spent any time reading about investing on Twitter or Reddit (especially in the controversial r / WallStreetBets known to increase stocks like GameStop earlier this year), you’ve almost certainly heard the saying “buy the drop”.
The ubiquitous advice – which refers to buying a stock or cryptocurrency right after a temporary price drop – inspired memes and a series of creative TikToks as influencers try to explain Why The strategy logic, Where mourn when purchasing the dip does not work.
You can even carries the saying, hang it in your room or listen to it on repeat thanks to the fans who turned the mantra into pop Songs. (Warning: the lyrics may be NSFW.) It even caught the attention of professional footballers. Tom brady and founder of Barstool Sports Dave portnoy.
But is buying on the downside really a good investment strategy? Not necessarily, according to experts.
“Just because a stock is cheap doesn’t mean you have to buy a stock. In fact, it can be one of the worst reasons, ”says Kimberly Woody, Senior Portfolio Manager at Globalt Investments. “Sometimes things are cheap for a reason. “
What does “buy the dip” mean?
Buying down refers to buying an asset, such as A stock or cryptocurrency, after its price has fallen from a recent high. Ideally, you’re getting a good deal, and if the price bounces, you’ll make money.
For many investors, the strategy is to simply keep an eye on a specific asset and buy when the price drops (for example, every time the price of Dogecoin drops, there are calls. on the other side the the Internet for investors to buy the decline).
Others take a more methodical approach. For example, they can set a certain threshold, like 20%, and when the market goes down that much, they invest the money they saved and continue to invest a fixed amount each month until the market returns to a new high. . Then they would start saving money again and wait for the next drop.
Regardless of the precise method, the idea is that in the long run, you will benefit from buying at generally low prices. But there are big risks.
“Catch a falling knife”
Buying the downside can quickly turn into an attempt to “catch a falling knife,” says Mark Gorzycki, co-founder of Ovtylr, a platform that analyzes how investor behavior influences stock prices . Catching a falling knife refers to buying an asset while its price is falling.
The problem with trying to catch a falling knife is that you can cut your hands. You cannot be sure when the price of a falling asset will rebound, assuming it does. And while you wait for other investors to buy the asset for its price to turn around, you suffer painful losses.
“Just because you bought it – just because you were nonconformist – doesn’t mean the herd will suddenly turn around and follow you,” Gorzycki says.
Buying the downside with the wider stock market may make a bit more sense than buying the downside with riskier assets like cryptocurrencies or memes stocks. This is because stock prices are usually tied to the financial fundamentals of a particular company, such as its growth potential and dividends. And these have value no matter what the mood of the market at any given time. So when a stock’s price drops, as long as you are sure that its underlying activity remains strong, you can also be sure that it will someday return.
But it’s harder to count on a rebound when you’re dealing with a fickle asset, like a stock or a coin, whose prices aren’t tied to fundamentals. Their performance of these assets really depends on something you can’t predict: the hype. And once the initial excitement surrounding them wears off, there’s no guarantee that it will return.
Speaking about the rise in popularity of Dogecoin earlier this year, Richard Smith, CEO of the Foundation for the Study of Cycles and an expert on financial cycles says money, “I don’t think that’s anything you could have predicted, or that we can be sure it’s going to continue.”
Time out of the market is costing you
Buying on the downside also requires keeping money in reserve when the market or overall asset you are tracking goes down.
But staying out of the market can have serious consequences. The market can jump quickly, too quickly for you to act. So if you aren’t already invested, you will be missing out.
Missing the 10 best days in the stock market over the past two decades would have cut your overall return by more than half, according to JP Morgan Asset Management Retirement Guide 2021. While the return on a $ 10,000 investment would have been $ 42,200 for a fully invested investor, it drops to $ 19,300 for an investor who missed those 10 key days.
It is far more important to participate in the better days of the market than to buy strategically when the market is falling, says Stephen Talley, COO at Leo Wealth. “It’s the weather in the market that really pays off,” he adds.
Also, if the market goes down but not as low as your threshold, you may be missing out.
Suppose you save money with the intention of investing it when the market drops 20%. The problem is that sometimes the market goes down, but not quite the amount that would reach your threshold, points out Nick Maggiulli, COO at Ritholtz Wealth Management, in a scathing criticism of the strategy in MarketWatch.
So if there isn’t a 20% market drop that you can buy for, but the market doubles, you’ve missed a chance to take advantage of those gains. Even if the market immediately plunges 20%, prices would still be 60% higher than when you started investing, he adds..
If you had a 50% drop-off point, between 1980 and 2000 you would have been away from the market with your money for 20 years as the market soared, adds Maggiulli. So, if the strategy can win a little, it can also lose a lot.
What should you do instead?
If you are looking to build wealth over time, a more suitable strategy may be cost averaging in dollars, which involves regularly investing a fixed amount in the market. The strategy is similar to buying on the downside in that some of your money will be held in reserve – but instead of waiting for a downside, you invest that money in the market regularly, like once a month or so. once per trimester.
For example, you could invest $ 100 per month for the long term, instead of saving that $ 100 each month in a bank account and investing hundreds of it when you think the market is going to go down. If a percentage of your salary is invested in a 401 (k) each month, you are already averaging the costs in dollars.
“Time is one of the best risk cancellation tools possible,” says Talley. And being diligent and controlled in your actions can go a long way, he adds.
In addition, when you establish a purchase average, you are buy dips sometimes – you just don’t have to try and time it yourself. As the name suggests, your cost is averaged.
Study after study has shown that investors are very rarely able to really getting money in and out of the market at the right time. But of course, it’s tempting to try. So if you want to try buying the downside, financial advisers recommend doing so with a portion of your portfolio set aside for fun investments like individual stocks and cryptocurrency. This part of your portfolio should be small, like 5%.
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