One thing you'll notice the longer you invest is that down periods in the market are inevitable. No bull market lasts forever, just as no bear market does. The better you understand that, the easier it is for you to ignore the short-term price movements in the market and focus on your long-term goals. It's much easier to do this during bull markets when you're seeing your portfolio rising, instead of during bear markets when your portfolio is seemingly dropping by the day.
Another thing you'll notice during these down periods is investors encouraging one another to buy the dip, which essentially means buying stocks after the prices have dropped a significant amount. If you're wondering whether buying the dip is a good investment strategy for you, it's likely the answer is yes.
It can be like discount shopping
Buying the dip is a good strategy, but it should only be one part of your larger investment plan, not the whole strategy itself. Your main focus should be long term, but that doesn't mean you can't take advantage of short-term moves to push you closer to your long-term goals. As stock prices are dropping, buying the dip gives you a chance to grab some of your favorite stocks at a discount.
Let's look at the market drop that occurred in early 2020 as the pandemic was beginning to pick up steam, for example. On Feb. 14, 2020, the Vanguard S&P 500 ETF (VOO -0.24%) was at $310.28. By March 20, 2022, the fund had dropped to $210.74. If you were an investor in the fund, instead of potentially panicking and selling your shares, you could have viewed this as an opportunity and bought the dip, increasing your stake. Even if you didn't catch the fund at $210 and bought it around $250, those shares would still be up over 40% since then, even after being down over 20% year to date as of July 13, 2022.
Buying the dip gives you a chance to lower your cost basis, which is the average amount you've paid per share of a specific stock. For example, if you bought 100 shares at $20 and 100 shares at $40, your cost basis would be $30. Your cost basis is important because it determines how much you eventually profit (or lose) when you decide to sell your shares.
Don't try to time the market
When considering buying the dip, you want to avoid trying to figure out where stocks will bottom out, which is much easier said than done. Why would you buy stocks today at one price if you can get them later at a cheaper price, right?
The problem is, you never want to find yourself in a situation where you're trying to time the market. Not only is the stock market volatile, and prices could suddenly rise while you were anticipating them falling, but even if you get it right this time, timing the market is virtually impossible to do consistently over the long term.
Instead, you should feel comfortable investing in the present at the given price or using dollar-cost averaging to make consistent investments over time. With dollar-cost averaging, you might find that you're buying stocks at a cheaper price at some times and a more expensive one at other times; that's just how it goes. What's important is that you stay consistent and not try to time the market.