Should You Buy the Dip?
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When the U.S. stock market takes a nosedive, it doesn’t have to mean doom and gloom for long-term investors. Rather than selling off, stock market dips like the ones investors have experienced throughout 2022 and 2023 can be a time to remain steadfast in your investments.
Stocks have seen some sharp downturns in the last two years due to interest rate risk, rising inflation, fears of a recession, and instability in the banking industry. But they've already started to recover from some of these setbacks.
In fact, a downturn may even signal an opportunity to “buy the dip,” or buy in at bargain prices.
'Buy the dip' meaning
“Buy the dip” is an investment tactic that follows the basic principle of “buy low, sell high,” but with a slightly more targeted approach. There are two requisites for buying the dip: a sharp decline in stock prices, and a strong indication that they’ll rise again. One of the more common examples of this is when a large corporation’s stock price drops suddenly due to broad market fears, rather than concerns about the company’s long-term performance.
To be clear, no one knows when the bottom hits, and trying to time the market is never a good idea. That being said, there are plenty of opportunities to invest in stocks during down periods if you’re ready to invest for the long term — and you know where to look.
How to buy the dip
Look at sectors hit hardest during the sell-off
Broad market index funds, which track a diverse stock market index such as the S&P 500, are a proven way to invest. But this same strategy can be applied to the 11 sectors that make up an index such as the S&P 500, too.
Taking a look at sectors with the largest share price declines, then analyzing the mutual funds or exchange-traded funds that track that sector, could shed light on a few opportunities to buy the dip.
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Look at large companies with big drops
Some blue-chip stocks that have otherwise been stable for years have been hit hard recently by a combination of the global pandemic, rising inflation and Federal Reserve interest rate increases, and their valuations have yet to recover. Looking for dips like those can provide an opportunity to buy into large corporations at their lowest prices in years.
This strategy comes with a warning, though: Be cautious when picking individual stocks, which can be volatile and overall riskier than more diversified investments like mutual funds, ETFs or index funds.
Max out your 401(k)
Investors may be encouraged to max out their 401(k) contributions during market dips, provided they have steady jobs and substantial emergency funds to tide them over should they need them. By upping your contribution, you’re essentially buying additional shares of investments you already own at a lower price.
But even maintaining the amount you’d been contributing before the dip would net you more shares per contribution, thanks to the lower share prices. Unless you need the additional monthly cash flow, the last thing you’d want to do is cease contributions during a down period.
» Learn more: This year's 401(k) contribution limits
Use dollar-cost averaging
If you have an IRA or other investment account, consider making steady investments at regular intervals, rather than a lump-sum contribution timed when you think is best. Through this strategy, known as dollar-cost averaging, you’ll continue to purchase shares throughout the dip.
401(k)s illustrate dollar-cost averaging in action: A percentage of every paycheck gets invested at regular intervals over the long term. Dollar-cost averaging can be used in all investment accounts.
The buy the dip meme
The phrase “buy the dip” has gained popularity through memes — particularly in the context of volatile cryptocurrencies such as and meme stocks such as GameStop.
But one of the most famous instances of the buy the dip meme illustrates the potential limitations of buying the dip: On May 9, 2022, Nayib Bukele, the vocally pro-Bitcoin president of El Salvador, tweeted, “El Salvador just bought the dip! 500 coins at an average USD price of ~$30,744.”
The price of Bitcoin had dropped more than 25% over the previous month, and has since continued a volatile fall. This is an inherent risk of any buy-the-dip strategy.
Limitations of buying the dip
Buying the dip does not guarantee getting in at rock-bottom prices. In volatile markets, today’s floor could be tomorrow’s high. All it means is that valuations are substantially lower than they were just a few months or weeks ago, offering investors an opportunity to buy at that relatively low price.
If you believe share prices eventually will rise to or beyond previous highs, buying at today’s lower prices could be a good strategy for generating long-term returns — you may just have to stomach a few big drops before you realize them.
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