Segment is a big advocate of buying market exposure on dips. However, an investor must use this strategy within a certain context; otherwise, the tail can wag the dog. Buying the dips can have an undeniably profound positive impact on long-term results. Segment’s three primary equity strategies all had fantastic 2020 results, due primarily to staying invested and adding to positions as the March decline accelerated. It was painful and required discipline but was surely profitable.
It’s a shame that our human nature makes us more inclined to liquidate into market weakness, not buy more. It’s the hot stove phenomenon; we naturally recoil from that type of stimulus. I have written many times about the numerous studies that prove investors hate losses three times more acutely than they enjoy profits. I know some investors who surely experience that regret as 10x. This trait accentuates our harmful recoil reactions and can have profound negative implications for long-term results. So the context that needs to be understood is that buying the dips must be only an enhancement or periphery event, if you will, within the context of a near fully invested portfolio. Adding market exposure incrementally on weakness has always been a good idea, eventually. The math gets a bit wonky though, if you are trying to enter the market ONLY on dips.
I recently asked our lead portfolio manager and CFA® charterholder, Ryan Farias, to crunch the numbers on the history of buying the dips as a way to enter the marketplace with additional cash. We used the S&P 500. He went back to 1988 since that data set is pure and without adjustments. Since we know the market rises in any 12-month time period in 81% of all cases, the issue we must grapple with is how ugly the losses are in the remaining 19% of the time. Those setbacks do tend to be more violent, but they don’t appear to be “worth waiting for.” That’s because the positive results that occur 81% of the time provide greater benefit than the 19% of drops would historically consume. I asked Ryan to compute the current value of $1 million invested in a myriad of patterns. We really wanted to isolate results derived using weak market action as a trigger to buy compared to longer hold periods or calendar-based frequencies of purchases. We analyzed calendar-based results from daily or monthly purchase frequency. We also analyzed the results from buying the dips ranging from -1% to -30%. The results were clear. The larger the dip you waited for, the longer the periods in between, and the more problematic to returns. In the final analysis, time is the winner of the debate, not market action.
Here is how we computed the results in the table below. We assumed an investment of $1 million in each case, invested evenly and incrementally according to a defined deployment strategy. We then calculated the returns and number of purchase events if an investor bought in daily, monthly, or if they waited for a specific dip in the market. On the dips calculations, we simply allocated the $120 daily number to a 3% money fund until the dip percentage was reached. Those dollars were then invested at that time. We also used time-only regimens of deploying the $1 million unrelated to market action. If spent equally and daily from 1988 'til now, you would have roughly 8300 buys. Buying less frequently, like monthly, did not harm results substantially but significantly reduced the number of purchases. All other market-price related purchase regimens considerably reduced the number of purchases but also harmed results more profoundly. I found it particularly interesting that waiting for a 20% drop produced the worst results of all. I surmised that simply reducing the frequency of purchases would be related to poorer results, likely emanating from extreme market lumpiness or extended periods between purchases. As it turns out, buying monthly caused the most infrequent buys of all and resulted in nearly the best results. I would infer that buying infrequently is fine for results as long as they are done consistently. In the end, the only way to get $1 million to $7 million by way of investing systematically over three decades was to do so by simply increasing calendar frequency, not using market fluctuation as a trigger.
Waiting may feel good, but don’t do it.