Oct 2, 2022 - Investing    No Comments

Buying the Dip vs. DCA

Or… why ignoring most investment advice found online is a good strategy.

There are thousands of self-proclaimed financial gurus online. I am not one of them (neither self-proclaimed, nor a guru). But experience has taught me that whenever someone is pitching as gospel a point of view that seems overly simple, it’s usually missing a few vitally important caveats.

First example:

This could be both really good advice. Or really bad advice. It’s hard to tell from that one sentence and monkey emoji. From my experience, the important caveats that are missing are:

  • As a singular investment strategy, he’s right: simply waiting around with dry powder hoping to luck into a “dip” worth buying into is a terrible strategy. The market moves up and down and there is money to be made regardless of direction. Any investment strategy needs to be broader than a singular philosophy based on market swings.
  • Buying select companies’ stock during this dip, however, is a an excellent opportunity. One I am taking advantage of as part of a broader investment strategy. GOOG is under $100/share. It joins AMZN, MSFT, and half of the stocks in the DJ30 in having a price not seen since early 2021. There is value to be acquired with this dip.

Second example:

The article includes many charts and illustrative examples on why Dollar Cost Averaging (DCA) is a better long-term strategy than buying the dip. And if I were only investing in the S&P 500 via an index fund, on a 20 year horizon, that might be a solid long-term strategy. But I invest in individual stocks. Not all of them trend to the S&P. I also don’t load up on investments that are doing well due to my max allocation guardrail. Nor do I try to lower my average share price when a stock drops below my trailing stop loss threshold. I simply sell the stock and walk away.

If I were to only scan the headlines in the article it would be easy to be convinced that DCA is the only stock investment strategy I ever need to learn and that buying the dip is akin to throwing gas-soaked cash on a bonfire. But buried in the details of this (realy, really long, self-referencing) argument is this little gem:

The only other rule in this game is that you cannot move in and out of stocks.  Once you make a purchase, you hold those stocks until the end of the time period.

WTF? Talk about burying the lede. What is this elusive time-period? Who defined it? Is it over the past 10 years? Or the past 10 days? Context here is important. Investing strategies are a bit like gravity: how the market operates at the macro (planetary) level can be completely different from how individual stocks operate at the micro (quantum) level. OK – that was a metaphor stretched too far (space-time warping??). But the point is: don’t blindly follow a single investment strategy simply because it was written by a seemingly smart person with a bunch of extra letters behind their name. History is littered with folks who bought Global Crossing, Enron, Sears, or countless others, then followed the experts’ advice and dollar cost averaged themselves to ruin as the stock went down the slide toward oblivion.

I need to have both an acquisition and an exit strategy before I buy. Remember: I never invest more than 10% of my portfolio in any one stock – and I always know what my sell strategy will be before I buy the stock. If I do not have the funds to buy the full position I want to hold on day 1, DCA factors in to my future plans. If I’ve bought 100% of the shares I’ve allowed myself to buy, then DCA doesn’t matter. I’m simply not going to buy more, regardless of what the price does.

Dollar cost averaging can be a great way to lower my average share price on a stock I’m long on when (1) the price is flat or falling, and (2) the fundamentals of the business still make sense, and (3) I’m still below my max investment threshold for that stock. DCA is a terrible strategy for me to follow when all three of these are not true.

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