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My Recent Experiences With Buying the Market on Dips

by Flexo on October 8, 2008

in Investing

Last week, I suggested considering tax-exempt money market funds as an alternative to high-yield savings accounts. As an example, I looked at one of the best options for me, the Vanguard New Jersey Tax-Exempt Money Market Fund (VNJXX), citing its 4.83% 7-day yield. Today, a week later, the yield is already down more than 100 basis points to 3.82%. This is still a great rate, beating the effective after-tax interest rate of all the top savings accounts, but it just shows that the best things don’t last very long.

Over the past week, I’ve also tried to take advantage of the dips in the stock markets. My first attempt was posted too late to get the price I wanted. Rather than buying VTSMX at $27.05 per share, my transaction wasn’t completed until after a rebound. The price I received per share was $28.42.

Realizing my timing error, and trying to take advantage of another decline at the end of last week, I moved money in my SEP IRA from a money market fund into VTSMX. This time I received a price of $27.04, one cent lower than the price I should have had with my initial purchase, but with a much smaller investment. Hoping for a rebound the following day, when the House was expected to pass the $700 billion bailout bill in its adjusted form, the market declined further, and I missed the opportunity to buy the fund at $26.62 per share.

I tried again on Monday when the market was in another decline. I timed the transaction right and received the day’s price of $25.56 per share for the same smaller amount of an investment. My quick trigger finger didn’t pay off this time, however, because the market continued to drop on Tuesday. If I had waited a day, I could have benefited from the price of $24.09 per share.

Each investment decision I’ve made during the current market downturn hasn’t paid off how I would have liked in the short term. The good news is that if the market continues to decline, I’ll have more opportunities to buy at lower prices. It may take some time, but the stock market should eventually provide acceptable returns.

It may be considered “market timing,” but I feel comfortable spending some money to try to “find” the bottom. Here are a few reasons.

  • I’m investing in small amounts so I am not risking a significant portion of my portfolio.
  • My time horizon for retirement is several decades in the future, so there is time for the market to ascend, even if we experience an extended period of a flat market in the next decade.
  • Timing the bottom is next to impossible, but buying when the market dips in its search for the bottom will help increase my chances of being close enough.
  • I’ll continue to follow automatic patterns for the bulk of my retirement investments, with an automatic investment in my 401(k) every two weeks and a bulk investment in my SEP IRA once a year.

Those who make market timing a main investing strategy end up performing much worse than those who follow the index. I do believe that it is worthwhile to include some form of market timing as a small part of an overall strategy, particularly if you are investing with the distant future in mind. Don’t expect to be able to time the market perfectly, but by going against the grain, buying smartly while everyone is panicking and reconsidering your holdings when the market is exuberant, you stand a decent chance of adding a little flair to your returns over time.

Of course, none of this will be true if the economy in the United States never recovers. But I find the chances of that to be very low.

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Tagged as: Investing, market timing, Stocks



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About the Author

Flexo, the owner and creator of Consumerism Commentary, has been blogging and writing for the internet since 1995 and has been building online communities since 1991. Find out more about him and follow him on Twitter.

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  • Flexo - Thanks for being straight up with your failures as well as successes. It's a lot harder to do what you are doing with mutual funds - how about some ETF trading?
  • ETFs would certainly allow more flexibility. I'm working with small amounts, so even a $4 trading fee on a $500 investment has a significant effect on overall returns. This is definitely something to look into, though, and I'll explore ETFs in the future.

    I think that my recent short term "failures" will still be helpful to my returns in the long run. The "long run" just may be a marathon, though.
  • I've been going through the same thing, trying to buy at the bottom on a severely down day, but the market seems like a bottomless pit and I keep getting burned in the short term. I'm 37, so I have some time for recovery, but I have to put a stake in the ground and keep my 25% in bonds in my 401K and not buy any more equities except through my paycheck 401K contributions. Even in that, I'm buying 40% bond funds so that I can time the market a little better in case the market goes down further. I agree that ETF's are a good way to go if buying stocks outside of an IRA or 401K. I bought a little bit of the gold fund and it has gone up these last few days. I wish I bought more. This is really getting scary. Now I'm wishing I was the type of person that didn't check my balances more than once a quarter. But then I would have had a heart attack come December :-).

    By the way, how do I make a profile on this site to get an icon and a link to my site. I can't find it.
    Thanks.
  • I agree on the ETF front. Much more flexibility if you're trying to hit a certain price point.
  • Pat Kane
    Sorry this is off topic, but did you ever finish your series of articles on your University of Phoenix MBA? It was riveting stuff....especially for me as I am considering taking the plunge.
  • Apex
    Flexo,

    I am impressed that you posted your loses after the fact and then defended why you plan to continue on your current path. I have seen others go silent when the market turns against their previously posted strategies. What you have done is honorable.
  • Jared
    Flexo,
    I challenge you to provide any evidence for the basis of your belief that "it is worthwhile to include some form of market timing as a small part of an overall strategy". If, as I suspect, this just a gut feeling, then I'd like to suggest that you research the issue. My research has led me to believe that effective and consistent market timing is simply not possible; not in a bear market, not in a bull market, *never*. Attempts to time the market are bound to revert to the mean. And you are bound to lose out in the long run because of the cost of lost opportunity. If you have extra cash lying around that you are using to "play the market", then your assets are not optimally allocated because that cash should have already been automatically invested or saved.

    Trying to time the market is good for exactly one thing - learning not to try to time the market.
  • Jared,

    If one believes that the market will go up in the long term, and you're investing in the long term, then it's never a bad time to buy. You might not buy at its lowest point, but it theoretically will get higher in 5 years plus. So he's kind of dollar cost averaging on the way down. It's better than dollar cost averaging on the way up even if he doesn't get the absolute lowest price at the bottom. It doesn't feel good watching a stock or fund go down after you buy it, but we may be vindicated one day with higher returns later.

    His extra cash may have been properly invested in something with safe low returns waiting for the opportunity for him to invest in stocks at a better price. I use bond funds as a buffer this way. Then I sell stock funds and put money into the bond funds when stock prices are high.

    Playing the market is all a big gamble, but a few percentage points here and a few there at each transaction can multiply out to make a significant difference. There is some luck, gut feel, and psychic power involved though.

    Atul
  • Jared: Any time you purchase a stock/fund/index you are "timing the market" because you are doing so on the assumption that the value of your investment will rise. Removing yourself and the state of the economy from the process by setting up systematic investments is probably the best way to invest, but dollar-cost averaging as the market is on the way down is risky (catching a falling knife is a popular metaphor) but if the economy recovers, and I think it will eventually, then buying close to the bottom is better than not doing anything at all.
  • Jared
    Atul,
    I agree that it's never a bad time to buy. Conversely, it's never a good time not to buy. That's why regular automatic investment makes sense and timing the market doesn't. Your cash is never properly allocated if you are waiting for the opportunity to invest at a better price. Because while you are waiting, in the irrational hope that you can time the market, you are losing the opportunity to be as fully invested as your risk tolerance allows when prices start to rise. My goal is to maximize the risk adjusted returns on my investments. That is a very different proposition from gambling and placing one's faith in luck, gut feel, or psychic power.
  • I side with Jared and Atul on this. Even if you get lucky and time the market one time, you will likely miss the next time. If you could always get it right, "the smart" people would always do it.

    This simple reason dollar cost averaging works is because you are investing a fixed dollar amount at regular intervals. Because of this you automatically buy more shares when the market is down and less shares when the market is up.

    You are seeing that the market is down, relatively speaking, and then deciding to buy more. That is timing and that is why you aren't going to beat dollar cost averaging.
  • Apex
    "Conversely, it’s never a good time not to buy. "

    This may be true for people who don't pay much attention or don't have any sense of intrinsic value but for someone who pays attention I disagree with this statement.

    Warren Buffet certainly doesn't follow it. He said repeatedly that he thought tech stocks made no sense in the late 1990s. Everyone said Buffet has passed his prime. He no longer understood the new economy. Ah, but sadly he did, and he was right and most everyone else is wrong. Markets and economies run in cycles. They get overvalued and undervalued. When they are not valued properly there is no guarantee they will quickly revert to the mean but intrinsic value can still be approximated using historical norms.

    Warren Buffet had no interest in Financials 2 years ago, but he does now. He has loved GE for decades. He said so last week. But he didn't invest until he got the right terms and he got options at a price he considers a bargain. Now granteed he is being given a sweet heart deal on these preferred stock deals but he has said that he believes there are long term values now that were not there before. Berkshire has been sitting on 40 billion of cash for years. Every year Buffet says he is looking for a good place to invest that money but none exist. Clearly he does not believe that it is never a good time not to buy.

    Again, I am not suggesting most people are capable of doing this. But just because most can't do it doesn't make the statement true. I know you have no way to verify this but I said the US stock market was over-value in late 1998 and made no sense to me. Unfortunatley I didn't follow my own advice and I stayed invested. I was 18 months early but I was right. I said housing made no sense in 2005. I was 2 years early but I was right. I said the current stock market was over-value in late 2006, and I actually did pull all of my funds to cash. I was about 1 year early on that and it took until this spring to get back to where I pulled out but I am very right now and have just started to nibble back in.

    So no I don't agree that its never a good time not to buy. Prices get to a point where they are being driven by pure supply demand when one or the other is out of balance with underlying values, and when that happens, its not a good time to buy. Identifying that conclusively may not be very concrete, but I think you can get close enough to know when it makes no sense to invest in certain things because even though they may go higher, the risk that the underlying values starts to be important again is too great and when I believe that to be happening, I take my money off the table. (Well I do now after not doing so in 1999, even though I said you should.)
  • Jared
    Flexo:
    By the way, thanks for Consumerism Commentary. I'm finding it interesting and educational.
  • Jared
    Apex:
    I agree that, in retrospect, it's possible to identify whether a certain time period *was* a good time to buy or not buy. However, I stand by my argument that timing the market is equivalent to fortune telling. Anecdotal evidence is not a strong counter-argument. The academic research is clear - there is a very high probability that any investment strategy involving market timing will revert to the mean. The lesson: don't try to beat the mean - invest regularly in an index fund.

    By the way, since you mentioned Warren Buffett... he recommends that individual and institutional investors buy low-cost, broad market index funds - not sector funds like technology or financial services. And when he buys shares in a company, as with GE, he pores over their balance sheets and then buys a controlling interest - that's not a strategy that you or I should be contemplating.
  • Apex
    Jared,

    I agree that most people can't do this and most people should buy index funds and most people should not try to time the market. My point was merely that I don't agree that people who are well informed in a subject area can't identify opportunities and over-valuations that allow them to time.

    I also agree that Warren's advice to most people is to not try to time or do any picking. He does buy a controlling influence often. But often he does not. He has no controlling influence in either Goldman Sacks or GE as is the case with many of the huge stocks he piles into. He just feels he knows their business and understands it well enough to determine when they are a good buy and when they are not.

    I guess it comes down to the old argument about efficient markets. If you believe markets are always 100% efficient and they always represent everything that is and can be known about the markets at any given time then no one has any ability to ever beat the market other than by shere luck. I think people like Warren Buffet and others prove that notion false. For instance one of the most common beliefs about investing is the need for diversification. This is because most people don't know enough to protect themselves. And this is why Warren recommends what he does for the average investor. But did you know that for experienced investors, Warren does not believe in diversification and actually believes it leads to sub par results. This can be evidenced by this quote from Warren: "Wide diversification is only required when investors do not understand what they are doing." And with respect to Warren's big investment timing secret: "We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful."
  • kitty
    I agree with Apex. Last year a friend of mine told me that her husband sold all of his stocks, bought gold and one or two of short ETFs. He did the same thing in late 90s. I thought about it, but failed to do anything - I was too busy counting how much money I'd have the following year in my 401K; and didn't want to sell equities outside of 401K because all of my stocks - I own individual stocks - were in good stable companies with good prospects and good fundamentals. Also his short ETFs were losing money initially. But now it turned out he was right. Sure the money I had in my individual stocks didn't lose quite as much as the rest of the market, but they are still down. Again, there have been plenty of warnings e.g. if a company reports good earnings, good guidance yet the stock barely goes up but an unrelated bad news causes it to go down the next day, this is a sign.

    It's difficult to catch ups and downs minute-by-minute, but I think people who follow trends have it right.

    Additionally, yours is a bad example. You use mutual funds where your trade doesn't go until later to try to time the market that right now is so volatile it goes up/down by a lot in the same day. Doing it with ETFs/stocks is different since your order is filled very quickly even if it is a market order; but you also have an opportunity to do a limit order i.e. set a specific price.
  • Jared
    Certainly there are market inefficiencies, but there is a high cost associated with trying to discover these inefficiencies - almost always higher than it's worth. There are hordes of investors spending considerable time and money trying to beat the market, and the great majority of them fail. Yet they continue to ignore this fact. Why? Maybe it's because the financial services industry spends so much money on advertising. Or, maybe people are misled by ever-present anecdotes about a friend of a friend who got lucky. Of course, there will always be someone who gets lucky. It's like the lottery. Somebody's bound to win, right? Yes, but look at the odds. Buying and holding low-cost index funds is as boring as can be, and it almost always beats the alternative.

    Here's an interesting article on the topic: http://www.nytimes.com/2008/03/09/business/09st...
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