Don't Buy Stocks on Sale

I've written before that I like to buy stocks/funds when they are on sale (in other words, when they take a bit of a downturn.) Well, the Wall Street Journal says this isn't such a hot idea:

Many investors assume a stock market "correction" of 10% or more is automatically a great buying opportunity.

They don't always pay off as well as you'd hope. In fact, Wall Street on average rose less in the five years following such a correction than it did at other times.

The average five-year price rise following the 19 corrections from 1950 to 2000 was 37%. But the average five-year price rise throughout the entire period was 52%. So much for being rewarded for taking a risk.

This all ignores the effect of dividends, which will smooth the results somewhat. (Usually the lower the stock market, the higher the dividend yield). It also ignores the effect of inflation.

But many investors simply assume that the stock market tends to rally sharply in the years following a selloff. It frequently doesn't.

The reason is that some declines proved brief, lasting a few months at most. (Does anyone remember the slump of October 1955?) Others, though, proved to be a harbinger of big, grizzly bear markets -- like those that began in 1972 and in 2000. On both occasions, the stock market went on to fall by nearly a half before bottoming out.

Ok, so that's the "con" part of the argument. I never look for stocks/funds I buy at low points to do great in the next few years -- I have a 20-year time horizon. And when you have this much time, the Journal says buying on a dip IS a good idea:

None of this should scare you away from the market. Long-term investors should probably take advantage of the stock market selloff right now to add to their holdings. But they should think twice before rushing to invest.

Unless you possess a crystal ball, the best way to beat a stock-market downturn is with a three-step plan.

• Buy.
• But buy small.
• And buy often.

This is pretty much what I do. I don't have a ton of cash on the sidelines right now (I do have a good amount, but that's for a downpayment in case we ever find a new house), so whatever I do buy, I buy in small amounts. And I do buy often. Been buying all the way down during this past drop. Anyone know where the bottom is? ;-)

Comments

[Zook]

That first part from the WSJ applies to whom exactly? If you get a $5000 check from your taxes in March and the market is on a dip, what exactly is the alternative the WSJ says you should try over a depressed stock market? If you are DCA into your taxable account, you shouldn't be buying when the stocks are depressed and instead you should put your money in a MMF?

I am confused.

[Dennis]

I think the first part of the article is aimed at people looking to "time" the market. They are just warning you that it doesn't always bounce back as quickly as you would like. If you are planning on keeping the money invested for 10 - 20 year, buying on dips is a great idea.

[Early Retirement Extreme]

"Many investors assume a stock market "correction" of 10% or more is automatically a great buying opportunity."

Many people .. hmm .. maybe that's the origin of bear market rallies.

The typical bear typically goes down by 30% thus eradicating a 43% gain. So it could go down another 20%.