“Buy the Dip”


Heuristics, like rules of thumb, help individual investors make quick decisions under conditions of uncertainty. Investing a lump sum prior to a sharp stock price decline is an outcome that many investors fear; it seems intuitive that investing a lump sum is risky. One popular heuristic for dealing with this concern is “buying the dip.” Rather than investing a lump sum of cash at the time that it becomes available, an investor may choose to hold their cash until the stock market has declined, allowing them to take advantage of lower prices while also avoiding participation in the decline that they had feared. This approach feels appealing because humans are loss averse – they fear taking losses more than missing gains.

The perceived attractiveness of “buying the dip” may become particularly pronounced when the stock market appears to be expensive based on measures like the Shiller price earnings ratio, or the market index reaching new all-time highs. Many investors take an alternative perspective; instead of waiting for a market drop out of fear, they might sit on cash hoping to make excess profits by investing after a drop and participating in a recovery. Some may even use leverage to increase their market exposure after a drop in hopes of earning excess returns.

While it seems appealing to “buy the dip”, the strategy implies that available capital is sitting idle while waiting for the right time to invest. This implication raises an important question about opportunity costs. Does the opportunity cost of waiting for a drop outweigh the perceived benefit of buying low? In this paper we set out to answer that question by testing “buy the dip” strategies in six individual country stock indexes, the MSCI World index, and the MSCI World ex-US index. We find no compelling evidence in favor of waiting for market drops to invest. Instead, we find that “buying the dip” is a sub-optimal strategy in both normal times and when the market appears expensive. On average, “buying the dip” trails investing a lump sum by a wide margin over 10-year periods.