I keep hearing people say that putting money into the stock market now, when it’s hitting new highs practically every day, is a bad idea, and that you should instead wait for the next dip or crash to invest. This seems sensible on its face. Why buy overvalued stocks now when you could theoretically buy them at a discount later and reap the rewards of a market recovery? Buy low and sell high, right? Unfortunately, it’s not that simple. I described in another article (Why Emotions And Investing Don’t Mix) how trying to time the market often results in lower returns than simply investing consistently on a monthly or yearly basis and holding your investments for the long term. Here I will discuss in more detail why waiting to buy the dip is often a bad idea.
It is hard to time the market
The first problem with waiting to buy the dip is that you have to be able to correctly predict how the market will move. Although many people claim to be able to do this, most investors are pretty bad at it. According to the 2017 Quantitative Analysis of Investor Behavior by Dalbar, investors have correctly guessed what direction the market will move in the next month 61% of the time on average from 1997 to 2016. They were better at predicting when the market would go up (guessed right 64% of the time) than when the market would go down (guessed right 50% of the time). However, what’s most significant to our topic is that when it came to identifying when a market crash would occur or when the market would bottom out, investors were only right 46% of the time. This means that, more often than not, investors were unable to identify peaks and troughs. And if you don’t know when the market will dip or when it has reached its lowest point, how will you effectively buy the dip?
For a recent example, consider February/March 2020 when the market crashed. In this case, it may have been possible to predict that a crash was coming because COVID-19 had already been causing problems around the globe. However, it hadn’t yet become very prevalent in the U.S. It would have been difficult to anticipate that the market would crash at the end of February through March since the federal government was still downplaying the virus at the end of February after the stock market had already started dropping. Once the market started to take big plunges in March, it was easy to say that the market was actually crashing, but that doesn’t mean that it was easy to identify when the market would hit bottom. Any of the three largest drops could potentially have been the bottom (March 9: -7.6%; March 12: -9.5%; March 16: -12.0%), but none of them were. Instead, the lowest day was March 23rd. Of course, any of those days would have been a better day to buy into the market than at the peak preceding the crash, which was on February 19th, but the point is that timing the market precisely is not easy to do, especially when many people are panicking about losing all of their money.
Buying earlier is better than buying the dip
One of the biggest problems with waiting to buy the dip is that people tend to stay in cash for a long time as they wait for the most opportune moment. This means that they often miss out on long bull runs, such as the one we’ve had for the last 10 years. They forget the importance of investing early to take advantage of compound interest over the long term.
Although a market crash is an excellent opportunity to enter the market, this neglects the fact that there is always an earlier time that would have been even better. For example, consider the bear markets we have experienced over the past 50 years, as identified in this Seeking Alpha article. There were six of them, shown in the following table:
|Date of bear market bottom||Percent decrease from peak|
These dates would have been the best times to invest in the past 50 years. The stock market had dropped precipitously by each one of them, ranging from a decrease of -27.1% to a massive -56.8%. If you were to buy into the market on these dates, somehow correctly identifying the exact market bottoms, you would end up making a lot of money. However, if you waited to buy into the market at these dates, you would still be leaving money on the table. If you look back before each of these dates, as you can see in the graphs of the S&P 500 below, there was always an even better time to invest which required no ability to time the market, simply investing earlier.
In each graph, the market bottom is indicated with a red circle, and green rectangles show dates that would have been better times to invest than during the market crash. In some cases, like the bear markets in 1982 and 1988, you would have been better off investing just 2 years prior. In other cases, like the bear markets in 1974 and 2009, you would have had to invest much earlier, about 12-13 years before the market bottoms. But in all cases, if you were waiting to invest until a severe market dip, you would have missed out on better times to invest that simply happened earlier. Even if you invested when the market was higher, or even at a peak, this would still not have been a bad time to invest in the long run. For example, if you had invested near the 2008 peak of about 1,500, this would still have been better than investing during the 2020 crash, when the S&P 500 reached a low of 2,237.
Don’t forget about dividends
Another problem with waiting for a dip to invest is that you miss out on dividends. Dividends are an often overlooked component of owning stocks that are actually quite significant. I, myself, did not realize how significant dividends were until quite recently. I preferred my dividends to accumulate as cash in my account rather than be reinvested because I wanted to be able to invest that money as I chose rather than get stuck with shares in a possibly bad investment. However, this money usually just sat in my account as cash for a long time, meaning that I missed out on opportunities for growth. I recently realized that I was looking at dividend reinvestment all wrong. When you reinvest dividends in a stock doing well, then the money from your dividends will likely grow even further. And when you reinvest dividends in a stock that has done poorly, you are buying more shares of the stock at a discount, which may allow you to make more money in the long term.
To illustrate the importance of dividend reinvestment, consider someone who invested $1,000 a month in the S&P 500 since 1970. Without dividends, that money would have grown to $8.8 million by the end of 2020 (without taxes or fees). But with dividend reinvestment, the investor would have ended up with $25 million instead, as calculated by DQYDJ’s S&P 500 Periodic Reinvestment Calculator. That’s a difference of over $16 million!
Let’s instead consider someone who only invested at the best possible times since 1970: the market bottoms of the six bear markets listed above. This investor saved $1,000 every month but only invested on those six dates in a lump sum. Without dividends, the money would have grown to $9.5 million by the end of 2020. You’ll notice that this amount is $700,000 more than for the person who invested $1,000 every month regardless of whether the market was up or down. However, including dividend reinvestment, the total for the individual who invested only at the best times would be $22.9 million. This is $2.1 million less than the person who never tried to time the market. Clearly, dividends are important, and missing out on them can have long-term consequences.
So should you try to buy the dip, saving up your money for when the market crashes to invest at the best possible time? The answer is a resounding no, at least for long-term investing. If you are just looking for short-term gains, then yes, investing during a dip and cashing out after the market rises will give you higher returns for your time in the market. However, you will end up with less money overall compared to someone who invested for the long-term whether stocks were up or down. And that’s assuming that you are even capable of timing the market at all, which most people cannot do with any accuracy on a regular basis. Just keep in mind that investing early and often generally outperforms trying to time the market, and make sure to reinvest your dividends for optimal growth.