Commentators often advise stock investors to “buy on the dips.” Jason Zweig took a detailed look at this advice and came up with the counter-intuitive result that buying on the dips doesn’t work.
This result is a tough sell, though. It just seems obvious that we’re better off buying stock just after a 5% drop than just before. What many investors don’t realize is that this is a false comparison. To be able to buy on a dip, you must have cash available that is designated for stock ownership but isn’t yet invested.
The next thing to consider is that you must keep this money available for as long as it takes to get to the next dip in prices. What if stocks rise 40% before the next 5% dip happens? You’re better off buying at 35% higher prices than 40% higher prices, but buying right at the beginning before the 40% rise is the best option of all here.
The fundamental problem with buying on the dips is the opportunity cost of holding cash that is not getting stock returns. Having cash on the sidelines works well sometimes, but works out poorly more often.