If you’ve spent any time reading about investing on Twitter or Reddit (especially in the controversial r/WallStreetBets known for pumping up stocks like GameStop earlier this year) you’ve almost certainly heard the saying “buy the dip.”
The ubiquitous piece of advice — which refers to buying a stock or cryptocurrency right after a temporary price drop — has inspired memes and a raft of creative TikToks as influencers try to explain why the strategy makes sense, or mourn when buying the dip doesn’t work out.
You can even wear the saying, hang it in your bedroom or listen to it on repeat thanks to fans who have turned the mantra into pop songs. (Warning: lyrics may be NSFW.) It’s even gotten the attention of football pro Tom Brady and Barstool Sports founder Dave Portnoy.
But is buying the dip actually a good investing strategy? Not necessarily, according to the experts.
“Just because a stock is cheap is no reason to buy a stock. In fact, it can be one of the worst reasons,” says Kimberly Woody, senior portfolio manager at Globalt Investments. “Sometimes things are cheap for a reason.”
What does ‘buy the dip’ mean?
Buying the dip refers to buying an asset, like a stock or cryptocurrency, after its price has declined from a recent high. Ideally, you’re getting a bargain, and if the price rebounds, you’ll make money.
To many investors, the strategy amounts to simply keeping an eye on a specific asset and buying when the price drops (for example, whenever Dogecoin’s price drops, there are calls across the internet for investors to buy the dip).
Others take a more methodical approach. For example, they may set a certain threshold, like 20%, and when the market drops that much, they invest saved up cash and continue investing a set amount each month until the market is back to a new high. Then, they’d start saving cash again and wait for the next dip.
Whatever the precise method, the idea is that in the long-run, you will benefit from buying in at generally low prices. But there are big risks.
‘Catching a falling knife’
Buying the dip can quickly turn into trying to “catch a falling knife,” says Mark Gorzycki, co-founder of OVTLYR, a platform that analyzes how investor behavior influences stock prices. Catching a falling knife refers to buying an asset while its price is dropping.
The problem with trying to catch a falling knife is that you can cut your hands. You can’t be sure when a plummeting asset’s price will rebound — assuming it will at all. And while you wait for other investors to buy the asset so its price turns around, you’re suffering painful losses.
“Just because you bought it — just because you were contrarian — doesn’t mean that all of a sudden the herd is going to turn around and follow you,” Gorzycki says.
Buying the dip with the broad stock market might make slightly more sense than buying the dip with riskier assets like cryptocurrencies or meme stocks. That’s because stock prices are usually tethered to a particular company’s financial fundamentals — like it’s growth potential and dividends. And these have value no matter what mood the market is in at any given moment. So when a stock’s prices sinks, as long as you are confident its underlying business remains sound, you can also be confident it will one day snap back.
But it’s harder to count on a rebound when you’re dealing with a fickle asset, like a meme stock or meme coin, whose prices are not tied to fundamentals. Their performance of those assets really depends on something you can’t predict: hype. And once the initial excitement surrounding them subsides, there is no guarantee it will return.
When talking about Dogecoin’s surge in popularity earlier this year, Richard Smith, the CEO of the Foundation for the Study of Cycles and a financial cycles expert told Money, “I don’t think that’s something that you could have predicted, or that we can be confident is going to continue.”
Time out of the market costs you
Buying the dip also requires holding some cash on the sidelines for when the overall market or asset you’re tracking drops.
But sitting out of the market can have some serious consequences. The market can jump quickly — too quickly for you to act on. So if you’re not already invested, you’ll miss out.
Missing the stock market’s 10 best days over the last two decades would have cut your overall return in more than half, according to J.P. Morgan Asset Management’s 2021 guide to retirement. While the return on a $10,000 investment would have been $42,200 for an investor fully invested, it drops to $19,300 for an investor who missed those key 10 days.
It’s way more important to participate in the market’s best days than it is to strategically buy in when the market falls, says Stephen Talley, chief operating officer at Leo Wealth. “It’s time in the market that really pays,” he adds.
Plus, if the market drops but not as low as the threshold you set for yourself, you could miss out.
Say you save up cash with the intention of investing it when the market drops 20%. The problem is that sometimes the market drops, but not quite the amount that would meet your threshold, Nick Maggiulli, chief operating officer at Ritholtz Wealth Management, points out in a scathing review of the strategy in MarketWatch.
So if there are no 20% market drops for you to buy in at but then the market doubles, you’ve missed a chance to profit off those gains. Even if the market then immediately dips 20%, prices would still be 60% above where they were when you started investing, he adds.
If you had a 50% dip threshold, between 1980 and 2000 you would have sat out of the market with your cash for 20 years while the market soared, Maggiulli adds. So while the strategy can win by a little, it can also lose by a lot.
What should you do instead?
If you’re looking to build wealth over time, a more appropriate strategy may be dollar-cost averaging, which entails regularly investing a fixed amount into the market. The strategy is similar to buying the dip in that some of your cash will be held in reserve — but instead of waiting for a dip, you invest that cash into the market regularly, like once a month or once a quarter.
For example, you could invest $100 each month for the long term, instead of saving up that $100 each month in a bank account and investing hundreds when you think the market will drop. If a percentage of your paycheck is invested in a 401(k) each month, you’re already dollar-cost averaging.
“Time is one of the best negating tools of risk possible,” Talley says. And being diligent and controlled with your actions can go a long way, he adds.
Plus, when you’re dollar-cost averaging, you are buying dips sometimes — you just don’t have to try to time it yourself. As the name implies, your cost is averaged.
Study after study has shown that investors are very rarely able to actually move money in and out of the market at the right time. But of course, it’s tempting to try. So if you want to try to buy the dip, financial advisors recommend that you do so with a portion of your portfolio set aside for fun investing, like individual stocks and cryptocurrency. This part of your portfolio should be small, like 5%.