Waiting for “The Dip” to Invest

A reader writes in, asking:

“Every year, I contribute to my Roth IRA as early in the year as I can and I invest the money right away. But I always wonder about waiting until the price goes down a bit before buying. I think I could even use a limit order to make it happen automatically. For example, buy VTI as soon as its price falls 5% below the current price. It feels like an easy way to squeeze an extra 5% return out for each contribution. Why don’t I hear about people doing this? Is it just because it’s more work or more complicated?”

I often receive emails from newer investors about assorted variations on this type of strategy (i.e., strategies that wait for some specific signal to buy, instead of buying as soon as possible).

The issue isn’t that a strategy like this is more work. The issue is that, on average, a strategy like this isn’t helpful.

With a basic version of this strategy:

• A “winning” scenario results in an additional one-time return of roughly 5% (or whatever percentage “dip” you decide to wait for) due to having purchased at a lower price, and
• A “losing” scenario happens when the market marches steadily upward, such that the intended purchase price never occurs.

And we can see an obvious asymmetry here, in a bad way. With the losing scenario the money never gets invested. You miss out on the investment returns indefinitely. In other words, the upside of the strategy is limited to 5%, and the downside is massive.

So then people often think, “OK, well I’ll also put in place a system to buy if the market goes up by some percentage, so that I don’t miss out on returns indefinitely.”

Let’s say you pick 5% there also. So now you’re not going to invest immediately, but you’ll buy as soon as the intended fund price falls by 5% or rises by 5%.

Well, which do you think is more likely to happen? Assuming you’re buying something that has positive expected returns, it’s more likely to rise in price rather than fall. So now, more often than the cases in which you buy at a 5% discount, you’ll be waiting and instead buying at a 5% higher price than you could have.

You can adjust either of those target percentages however you like, but fundamentally, the effect of wait-for-a-buy-signal strategies is just that: you’re waiting. Relative to investing the money as soon as it’s available, strategies like this reduce the number of days that you’re in the market. So the relevant question is whether the days that you are out of the market have a positive or negative return.

And of course, more often than not, the stock market has positive returns. That’s the whole point of investing in the stock market.