By Joe Aylott, Multi-Asset Strategist
Investors looking to boost their investments this year may choose to adopt the strategy of ‘buying the dip’. This refers to the strategy of waiting for a stock market to first fall before buying shares.
However, such a plan could lead to missing out on potential returns rather than maximising them.
Buying the dip has become a popular investing maxim over the last decade or so. Markets have often quickly bounced back from sell-offs, rewarding investors who get the timing right.
That’s the theory anyway. However, our research suggests that, while buying the dip can pay off sometimes, getting the timing just right is notoriously difficult, and so a more optimal approach is to stay invested over the long term, focus on economic fundamentals and hold diversified assets that could reward investors over time.
Past performance should not be taken as an indication of future performance. You should continue to hold cash for your short-term needs.
Does ‘buy the dip’ work?
We put the ‘buy the dip’ theory to the test. We compared the returns of an investor who bought stocks on the first day of the year to someone who stayed in cash and waited for a 10% peak-to-trough drawdown – colloquially termed a market ‘correction’ – each year. We looked at S&P 500 total returns from 1990 to 2024.
The results tell a very clear story.
If you waited for a 10% correction before investing each year you would have experienced average returns of 6.6%. By comparison, those who invested on the first day of the year regardless of market conditions would have seen average returns of 12.1%.
Furthermore, over the 35-year period, only around half the years included a 10% sell-off. This means that, during the other half, those who stayed in cash waiting for a sizable drawdown would still be in cash at the end of the year – missing out on any positive returns.
And there would have been a lot of returns to miss out on too. Around 80% of the years over this period ended in positive territory.
