“Buying the Dip” an Explanation
Hi everyone, and welcome back to Melissa Making Cents!
CERTIFIED FINANCIAL PLANNERS™ and financial coaches are aware of those corners of the internet where users give others general "fool-proof" financial advice. Many financial planners would ignore this small segment of the population entirely; however, I think it's important to inform my clients of the good, the bad, and the ugly surrounding internet-forum financial advice.
The hard fact is that even though many of these users claim to be educated experts - they're often self-educated. I don't want to go out of my way to shame people for self-education. In fact, I think it's excellent, and that's what this entire blog is about - bettering yourself and your finances through self-education! Unfortunately, not all of those who claim to be experts and self-educated have the breadth of knowledge as financial planners who spend their careers devoted to helping individuals and their personal finances.
Of course, the most treacherous aspect of taking advice from people online is the bravado and certainty with their claims. Obviously, on a forum, many people could post to have a deep understanding of any subject. However, the real issue is when people listen without doing their own due diligence, many a potential fortune can be squandered in the pursuit of following the financial advice of strangers.
A Short History of “Buying the Dip”
I detail the dangers of following internet-forum financial advice because there's been a semi-recent uptick in activity on forums, like Reddit, where users urge others to "Buy the Dip." Those who aren't necessarily well-educated in finance or not financially minded may be confused by this! What does it mean to “Buy the Dip”? Where does the phrase come from? Is it sound advice? If it is, is it sound advice in any situation?
Well, that's the exact reasoning for this article! So, let's dive in and unearth everything we can think of about "Buying the Dip."
Perhaps a great place to start is the origin of the phrase itself! The phrase buying the dip is a longstanding phrase, and it's challenging to track down its source. However, the phrase has been used in financial circles for years and years. More recently, it’s become a popular catch-phrase slogan for internet memes and participants in online financial forums, like "wallstreetbets" on Reddit.
The phrase has caught a lot of attention lately because this financial move can make a person quite a bit of money if they're smart, lucky, or both. Unfortunately, buying the dip is based mainly on speculation and anticipation. While it has a history of making investors a large amount of money, it also has an equal (if not greater) history of losing investors’ money.
The General Strategy of Buying Dips
One thing that contributes to the popularization of buying dips, especially in novice finance circles, is the ease of strategy. It’s as simple to explain as it is to understand; however, pulling it off is a different story.
"Buying the Dip" means literally waiting for an asset to dip down to a "low" price before investing in it. Waiting for the cost to bottom out before buying allows the investor to pick up as many shares possible on the cheap. The investor then holds these assets while waiting for the price to rebound or surge, at which point they’ll be able to sell their investments for a steep profit.
See? It's not difficult at all. It's straightforward and easy to understand, and it's a strategy that has been used throughout the history of the stock market. But unfortunately, this simple hat-trick gives false confidence to some interested in investing and making money but perhaps not so interested in learning about financial principles.
And while this strategy may work at times, it relies on an unobtainable future knowledge of investment performance. A false sense of confidence may lead investors to make an investment that they believe to be relatively risk-free. That may cascade into that person investing a large amount of money into something with much more risk than they think.
Countering Opinions of Market Dips
To be totally fair, I did spend a large amount of the previous section devoted to pointing out some of the countering opinions of those who oppose the idea of buying the dip. However, I’ll use this section to lay them out explicitly and state some alternative strategies that investors may use to make less risky and more financially sound investments.
As I stated previously, the risks of buying the dip do exist. While some may believe and tell you otherwise, one of the principles of finance is that nothing is without risk and that the future cannot be predicted with any difference of certainty. In other words, when someone tells you to invest and buy the dip because it’s sure to go back up and that it’s a risk-free investment - turn on your heels and run the other way!
Any investment requires an assumption of the future - right? Any time you invest in anything, you’re making a prediction that the future of this investment will be positive. The difference in buying the dip and speculation versus more sound options, like investing in mutual funds, is the amount of risk you are willing to take on.
A mutual fund operates by investing money across various stocks, bonds, and other investments, which mitigates the risk you take. However, novice investors all-too-commonly go "all in," leaving none of their money back - because it's a "sure thing" when buying the dip. The problem is that no investment is ever a sure thing, and you’re risking putting all of your eggs in one basket instead of spreading your risk across multiple assets.
Limitations To Buying the Dip
Perhaps the strongest limitations of putting all your eggs in one basket and buying the dip is twofold. The first stop on our list of issues is that of predicting the future. No person can predict the future, whether they're a garbage man or a financial planner. We can only say what we believe may happen with a degree of certainty. While sometimes these predictions are very close to reality, often they’re also very far off. And... to be fair... a broken clock is also correct 2 times a day!
To illustrate this, think of one of the most notorious camera companies of the pre-digital age - Polaroid. Polaroid was on top of the world! Their cameras could spit out pictures on the spot when the photo was taken. By all accounts, Polaroid was on track to stay the course and dominate the user-friendly camera and picture industry indefinitely.
There's only one problem! At the height of Polaroid's reign as king of the selfie, a new piece of technology was invented, improved, and mass-produced called the iPod. The iPod would eventually become the iPhone, which influenced cell phone manufacturers everywhere to begin vigorously working on their cameras which were able to show the picture without even being printed!
The next stop on our list of issues is referred to in economics as an externality. According to Investopedia, "Externalities occur in an economy when the production or consumption of a specific good or service impacts a third party that is not directly related to the production or consumption of that good or service.” In simpler terms, an externality is a non-business event or issue that either bolsters or hinders the profitability of a business.
Here are two simple and easy examples of externalities that affect businesses: the coronavirus pandemic and the Ukraine crisis. No business or average consumer could have predicted these events ahead of time, and it would be ridiculous to believe they had no effect on profits or prices.
Risk and Mitigation
As with any investment or investment strategy, buying the dip comes with a certain amount of risk. Typically, a financial planner or financial coach will guide you and help you make choices that align with something we call your risk profile!
For those who may be unfamiliar with this term, a risk profile is an assessment of an individual's risk tolerance or the amount of risk one is willing to take on with comfort. The risk profile helps financial planners tackle investments and investment strategies that fit to the investors they're working with. Mitigating risk often comes with the cost of declining return on investment. In other words, (generally speaking) the riskier something is, the more potential return there is to be had, as well as potential loss. This works both ways meaning that the less risky something is, the less you stand to make from that particular investment.
One issue with buying the dip is the lack of risk mitigation. That means that instead of spreading risk across multiple investments for a more stable return – you’re dumping a lot of money into one or a few investments in the hopes of one of them hitting it big. And yes – going all-in on buying a dip can make one a lot of money. But unfortunately, it also comes with the substantial risk of losing a lot of money by investing in an imprecise way that may not consider the individual's risk profile.
Bitcoin and Other Cryptocurrencies
Another phenomenon of this conversation and how buying the dip came into mainstream popularity among less experienced finance gurus is cryptocurrency!
Cryptocurrency is a new and exciting form of digital currency that's been around a while and surged into popularity with Bitcoin's momentous rise around 2017. In 2017, the price of Bitcoin rose from around one thousand dollars per Bitcoin to about twenty thousand dollars per coin. This made a gigantic splash for those who invested early into the cryptocurrency! Millionaires were made over just a few weeks and months.
Since that time, there have been several peaks and valleys in Bitcoin history. It has risen and fallen through the years and hit an all-time high in 2021 of around sixty-five thousand dollars per coin.
The steep and quick peaks and valleys of Bitcoin have led to millions of people buying cryptocurrencies in bulk, hoping that a similar occurrence will eventually happen. However, there have been some surges in other coins since Bitcoin's introduction. Notably, Dogecoin and Ethereum have become the mainstream and have been favored to speculate on.
Buying the dip is very important to this discussion of Bitcoin and other cryptocurrencies. It's become somewhat of a siren call to those interested in the crypto world. One reason this may be the case is that crypto, thus far, has been widely unregulated, and platforms have emerged which allow the everyday consumer and amateur investor to speculate on cryptocurrency.
Dollar-Cost Averaging
One popular investment strategy that you and your personal financial planner may be interested in exploring is Dollar Cost Averaging. In essence, dollar cost averaging invests a fixed amount of money into an investment at any one particular time.
By investing no matter the price per share at regular intervals, you're assuming that you're getting the best bang for your buck in the long haul of investing! This is because you’re limiting the number of shares you purchase when their price is high, and you're buying more shares when their price is low.
Investing a percentage of your available funds, instead of all your money, at one time also does a great deal to mitigate risk over time! A strategy like dollar-cost averaging could easily be combined with mutual funds to strategically get the best average price over time with a steady and less risky return on investment!
Sound Financial Planning and Investing Principles
So, there you have it! Now you have an excellent overview of what it means to "buy the dip," including the good, the bad, and the ugly! But, before we're completely done, let's do a little refresher!
"Buying the Dip" is a longstanding strategy primarily used by amateur investors. Buying the dip has become even more popular in recent years because of internet success stories, amateur and novice investing forums online, and the emergence of cryptocurrency! Buying the dip and speculating the market is attractive partly because of how simple of a strategy it is – buying low and selling high means big profit. The only problem is that we can't see the future, and we're doing little to mitigate risk through diversification or time. Other issues are not knowing when a "good" time is to buy or sell and unawareness of externalities that could affect your investment. All these problems lead to buying a dip is very high risk/high reward undertaking – while you could make a ton of money, you’re just as likely to lose money.
There are, however, other ways to build wealth! By working with a financial planner, you can make intelligent investments using tried and true strategies based on math instead of gut feelings! A good financial planner can help you with dollar-cost averaging, diversification, reinvesting, and other great techniques that mitigate the risks that buying a dip brings.
If you or someone you know is ready to jump from novice investing to making less risky and better-protected investments in your future, please call or email to schedule an appointment with me. I'll work with you to create a financial plan specifically made for you and your state of residence (whether it has state income tax or not).
Together, we can create a financial plan that's an excellent fit for you and your state!
Until next time...this is Melissa Making Cents!
Melissa Anne Cox, CERTIFIED FINANCIAL PLANNER™, is a College Planning and Student Loan Advisor and Financial Coach in Dallas, Texas.
