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When Buying the Dip Doesn’t Work: An Analysis of the Dot-com Crash
When a sale isn’t quite what it seems to be
Since March 6, 2009, when the S&P 500 hit its low point during the Great Recession, one investing strategy has reigned supreme: buying the dip.
This approach is pretty simple. When the market falls, you invest money. Essentially, you buy stocks on sale and, a short while after you buy them, you basically are in the green. It’s been simple, easy, lucrative, and has come with very little in the way of downside.
Why has this strategy been so profitable and painless? Well, because stocks have been in a bull market for thirteen years.
Now, you may stop and say that this is certainly not the case. After all, there have been plenty of double-digit percentage downturns along the way, with the largest being the COVID crash.
While those downturns were uncomfortable, they aren’t in the same league as some of the most infamous bear markets. The most notorious of these bear markets is, of course, the Great Depression. But another great (and more recent) example to study is the dot-com crash. To see that, we can to take a look back at the QQQ, which is an ETF that tracks the Nasdaq 100:
At the beginning of this chart, you see a fairly high starting value and downturn. It doesn’t look like much compared to the run up we have today. The same can be said for the Great Depression not looking like much on a chart that extends to present day. Because of that, it’s easy to underestimate the pain of those past downturns:
This chart gives us a better feel. That massive gap is the hole the crash put on the index for over sixteen years.
Let’s zoom in on just the crash itself, which is the first two-ish years of that chart:
Here we see the relentless and drawn out decline. This wasn’t a dip that lasted a few months. It lasted years. The index dropped from $117 to just over $20 bucks.
This is where someone who has gotten used to the recent bull market might say, “This was a dip worth buying! Consider the opportunity of buying this index that low when you see how high it is today!”
That’s totally true! I’m not saying that buying the dip here was dumb. Putting your money away for a long time so it can grow is smart! But the long horizon factor is just plain old investing. It’s not really about buying the dip.
Buying the dip during this time, after a long holding period, did work out. But let me explain why buying this dip was different - it came with a level of pain that nothing in the last thirteen years has ever come close to. Let me show you the details of why:
First off, if you bought at the top, you wouldn’t see a new high on your investment for 16.5 years. And if you held on, you got to experience a -83% drop along the way.
Now, imagine you bought the dip! Maybe the market went down -20% into a classic bear market. You buy the dip and what’s the reward? Now you only have to wait 14.2 years and endure a -78% drawdown before seeing a return on your investment.
What if you bought the dip after a drop worse than what we had during the COVID crash at -40%? Then you wait 11.8 years to get your money back and have to suffer a further -71% drop.
And, if you are a super dip buyer and bought after things fell -70%, you would still have to wait 2.5 years to recover and stomach a -42% drop.
Think about that for a second.
You bought a -70% dip and you still have to deal with a further crash that is even worse than the COVID crash and lasts about five times as long.
See, I’m not trying to rain on the parade of everyone who wants to buy the dip. I think buying things on sale is smart! What I am saying though, is sometimes, a dip is not just a dip. It can be a small part of a much larger crash and those sales suddenly don’t return easy gains in a short period of time.
We’ve been in a thirteen year bull market. Buying the dip during this period has been great. However, investing at regular intervals has also been great!
Buying the dip isn’t some secret strategy. Time is the secret strategy.
Things are easy until they aren’t. The challenge is that we rarely know when things are going to be easy and when they are going to be hard.
Sometimes the game changes and we don’t even realize until it’s too late to adjust our strategy. A sound defense then is a constant vigilance, a healthy dose of skepticism, and a mentality of preparing for the worst and hoping for the best.
That’s a strategy you can take with you in all market seasons.