How to Face Up to Buying the Dips

All investors are prisoners of the past, and that shapes how they face the future.

Until a few weeks ago, stocks were like a perpetual money machine, rising steadily for nearly a decade and a half. From March 2009 to this January peak, US stocks have risen more than 800%. Pandemic panic in February and March 2020 lasted only 5 weeks.

So it’s understandable if you think that the nearly 20% fall so far this year is just a blip. The stock will soon resume its smooth upward run, right?

I hope so too.

For all we know, however, the coming years could look like 1966 to 1974 or 1929 to 1943, long streaks of down days as stocks keep going up and down but essentially over where they start.

In that case, you’ll need a new weapon in your psychological arsenal. The final years of poor inventory returns will afflict those who aren’t prepared for the long haul.

One weapon to consider is called the mean. It’s like buying at a discount — buying more stocks when the price drops — on steroids.

Basically, this technique combines two basic ideas: dollar cost averaging (putting money into automatic monthly or quarterly) and rebalancing (selling some of your winners). and buy some of your losers).

In value averaging, you set a target amount that you want your account to grow over time. Let’s say you want to end each month with $1,000 more than you started.

During periods of stock price decline, you must replenish your holdings with enough money to reach the goal you’ve set.

For example, if the value of your portfolio fell by $250, you would need to buy $1,250 in stock to end the month with $1,000 more than it started with. If the value of your portfolio falls by $500, you add another $1,500, etc.

In a rising market, you would buy less than $1,000 – and even sell some, if the stock price goes up.

Value averaging is the brainchild of Michael Edleson, a former chief economist at the Nasdaq stock exchange and a former chief risk officer at the University of Chicago.

Most investors say they intend to buy and hold – but instead, many investors buy high and sell low.

Investors using averages are “prepared to bury their demons,” said Mr Edleson – “the devil of greed makes you buy high and the demon of fear makes you sell low.”

However, this technique cannot eliminate the risk of underperformance. “If you choose certain time periods, the mean can look horrible,” said Mr. Edleson. “Your success always depends on the beginning and the end.”

This strategy is better when volatility is high and worse when the stock rises or falls favorably. In a stable and long-term market, Mr. Edleson said, “there is nothing better than buying and holding, just sitting on it.”

Buy low, buy lower

In this simple example of a market that drops every month in constant volume, different buying methods lead to very different results.

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So value averaging is a type of bet that the market won’t return to an unusually smooth upward slope any time soon, such as in the mid-2010s. If you think they will, it might. not for you.

Harald Deppeler, 53, a semi-professional physicist in Zurich, has been using this method since 2013. He has built his own spreadsheets to do so; most financial firms are not set up to automate averages for clients.

The approach “gives you a feeling of having a slight edge, but it also tests you,” Mr. Deppeler said.

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When the stock rallied favorably from 2013 to 2018, his shares in the S&P 500 fund exceeded the target, so Deppeler had to sell about 8% to 12% of that position, he said. (Capital gains are not taxed in Switzerland; as a rule, US investors should only consider the average value in tax-deferred retirement accounts.)

Mr. Deppeler said he was aware that having to sell off his holdings during a long bull market could cost him a small portion of the profits left behind, although he hasn’t counted that. calculate that opportunity cost. “I have a bunch of cash, which I can’t use,” he said.

On the other hand, in March 2020, the median value forced Deppeler to put “six-figure sums” into his S&P 500 stock fund during a massive slump. “It forced me to say, ‘The market is still falling, and now I have to buy,’” he recalls.

“At that point, I had to constantly say to myself, ‘This is a real plan designed to make you buy more when the market is down. Mr. Deppeler said.

“If someone can really take the right amount of money, put it in the stock and let it move, rebalance but otherwise hold, I wouldn’t tell them the value,” Mr. Edleson said. average is better”. “But in reality not many people can do that.”

Then again, if you don’t have the discipline to buy and hold, you may not have the additional discipline to buy more in a bear market.

Less is harder than buying more when the market is down. That’s why discipline is an investing superpower. The average can help some people stay on track — but it needs to be effective, and it won’t work all the time. Then again, in the markets nothing works all the time.

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Edmund DeMarche

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