Do you remember that time you had a squirmy feeling?
Like you were uncomfortable and just want to sink down into your chair.
You might grimace. You might cringe.
That’s how I feel now when people ask me… should I wait for a dip?
What I mean by a dip is a small downward change in the stock market. I don’t mean a 20% or 30% bear market. Think instead a 5% to 10% correction.
The market was at $100 and is now at $95 or maybe $90.
It feels like this happens all the time and is really common.
To be honest, for the last 20 or so years of my career --- I thought waiting for a dip was a good thing.
A 5% to 10% correction feels like it happens every year. We know the stock market moves up and down all the time.
Wouldn’t this be a good time to buy?
After all, aren’t we supposed to buy low so that we can sell high?
Isn’t it better to be patient?
I always thought this was true…. But then I did some research.
Should You Wait for a 5% Dip?
The first question I had to answer was how often does a 5% dip happen?
Check out my table below based on research I did on Yahoo.com.
What certainly jumps out is that 22 out of 23 years there has been a 5% dip.
That would mean there’s a 95% chance that we’ll have a 5% dip.
It’s very, very likely.
You’ll notice when we look at a relative height for the market that they are all over the place. Sometimes, it’s in January. Other times in March. Others times in July and so on and son on.
Same deal with the relative low. Sometimes it’s a month or two. Other times it takes 7 or 9 or 10 months to get to that point from the relative high.
The next question is--- what if you bought at that 5% dip?
Would you have been better off to buy at that dip?
My hypothesis was that yes, we would be better off.
Here’s what I found out:
I’ve highlighted green any year where your gain was great than if you invested on January 1st by waiting for the 5% dip.
I’ve highlighted yellow any year where it’s nearly the same.
I’ve highlighted red any year where you lost relative to investing on 1/1.
Just by glancing at the chart, you can see an awful lot of red.
It adds up to 13 out of the 23 years.
Yellow is 3 years.
Green is 7 years.
Clearly, at a 56% probability of turning red, it DOESN’T seem to make sense to wait for a 5% dip even though it happens about 95% of the time.
The reason why this happens is because the market often turns up BEFORE it turns down.
Imagine the market moving up 10% and then dipping 6% --- it’s still behind by 4% relative to investing at the beginning of the year.
If the year ends up +15% if you bought at the beginning of the year, you’re up 15%. Meanwhile, if you bought at the dip, you’re only ahead +11%.
Of course, this isn’t always true, you have a 44% chance that waiting for a dip will not hurt you and maybe even help you.
Overall, I conclude that waiting for a 5% dip is not a sure fire way to enhance your profits and you are much better off just simply buying off at the beginning of the year.
Ah…. That’s a 5% dip, but what about a 10% correction????
Should You Wait for a 10% Dip?
Let’s take a look at this table.
What a difference from the last table!
Clearly, there’s a lot more red here.
14 times out of 23 are green and 9 times out of 23 are red.
If we use those averages, we should expect a 10% correction about 60% of the time.
Yet, that means 40% of the time it may NEVER materialize.
4 times out of 10 you could be waiting and waiting and waiting and waiting for a 10% correction to happen and perhaps the market moves up and up leaving you behind in the dust.
I know this is something that I’ve seen and experienced before.
Yet, 10% corrections are regular--- we should expect them to happen quite often.
This leads us to the next question--- for those years when it does happen--- how would you do if you bought at a 10% correction?
Of those 14 times, 12 times have turned out to be very positive or about an 85% chance that you’ll beat the market for the year and only a 15% chance of not doing so.
Again, a very stark contrast from our 5% dip.
What I conclude here is that we should NOT wait for a 10% dip. However, when it does happen--- we should look to add to stocks.
I would suggest doing so through a rebalance where if you had 60% in stocks before and now have 54% in stocks, get it back to 60%.
So, we’ve covered 5% and 10%, what about a bear market of 20% or even 30% correction?
What about a 20% or 30% Bear Market?
As we move to bigger and bigger %, we have less and less instances. Check out the table below.
Only 6 years have had a -20% correction and only 3 years of the last 23 have had a -30% change.
That’s about a 25% chance to get a 20% change and about a 10% chance to get a 30% change.
Here, it becomes clearer and clearer that it makes sense to buy. Keep in mind that this doesn’t guarantee a profit for the year, but it surely gives you a great chance to potentially beat the market.
In my opinion, at a minimum we should consider doing another rebalance at 20% and 30% should we get there.
I do wonder if potentially we should even re-examine risk tolerance when the markets are down -30% and consider even moving up in risk tolerance to take advantage of a very unusual situation.
As we examine the past data here, it becomes clear to me that we should not wait very long (if at all) for a dip, even a 5% one.
However, it does show me that at a 10% dip, a 20% correction, or a 30% bear market, we should consider at a minimum doing a rebalance and perhaps even re-evaluate risk tolerance to see if it makes sense to take more risk.
What do you think after reading this?
Are you going to wait for a dip? Why or why not?
Let me know your thoughts. Send me an e-mail at email@example.com
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