Most investors have heard of the idea of buying the dip, which is buying shares of a company you like when they're at a lower price than before, with the goal of getting a discount. In practice, dips are difficult times to invest, especially for those who are risk-averse.
But, with a little discipline, it's possible for most of us to get better at recognizing and acting on opportunities to buy quality assets at cheaper-than-usual prices. Let's use Costco Wholesale (COST -1.72%) as an example case to explore what you might be thinking during dips, and what to do to turn these periods of uncertainty into times of opportunity.
What you're feeling during the dip
Here's how Costco's stock performed compared to the S&P 500 ETF Trust over the last three years.
SPY Total Return Level data by YCharts.
The brutal bear market of 2022 is where the first part of our lesson lies. Imagine that in January, you bought a sizable number of Costco shares for the first time, as I did.
Your investment thesis might have been something like this: Given the company's consistent execution of its business model, in which it provides membership-gated low-cost groceries and consumer goods, it should perform decently even in a market with blustering macroeconomic headwinds.
But when most of us first make a new investment, even if we've done a lot of research beforehand, our level of confidence in our decision is not the highest. Until there's a decent gain registered in our account, it's usually too soon to say that a certain move was the correct one. And, as you can see on the chart above, in early January 2022 the odds were good that your Costco shares would seem to start losing value more or less immediately after you bought them.
Everyone has heard the phrase "Don't throw good money after bad," and most are familiar with the idea of the sunk cost fallacy. With those two thoughts in mind, not to mention the glaring red numbers in your investment account, you probably wouldn't have been in any mood to buy more shares, though you probably weren't about to give up on your investment thesis and quit your position just yet.
This is how you missed the first opportunity to buy the dip -- you'd just bought in, and it wasn't going very well. It didn't seem to make sense to commit more capital at the time. In any event, your shares would soon recover their value -- check the chart again and look at the first and second quarters of 2022 -- only to then crash to an even lower level than before as the Federal Reserve's interest rate hikes sent the market into a tailspin.
Now the idea of selling for a loss to prevent further losses would have started to look a lot more appealing. With the media constantly reporting a drumbeat of bad news regarding inflation, it probably seemed prudent to reduce your exposure to risk on the market rather than increasing it by buying more Costco stock.
Who would be willing to buy more shares during such an overtly bearish period? Clearly, only someone interested in losing their money.
This time around, focusing on the difficult macro conditions was an easy way to talk yourself out of buying the dip. The dominant narrative of bearishness meshed with the poor performance of the investment, and it compounded the fear of experiencing more losses, which likely resulted in inaction.
Holding on to the shares for a little bit longer wouldn't have done much to assuage investors' anxiety on that front. The stock was down by 19.6% for the year. After a year of sleepless nights and increasing pessimism about the stock's future value, most investors would be in no mood to buy the dip.
But look at the price chart again. Actually buying these dips eventually led to great returns. There were not any juicy opportunities to buy the dip again over the next year and a half after 2022.
Opportunity knocked several times, and there was a seemingly reasonable justification to say no out of a sense of fear each time.
There's a workaround for dip-buying shyness
The crux of the story above is that it is easy to talk yourself out of taking risks, especially in turbulent times, and even more so when you've just taken a risk that isn't delivering the returns you had hoped for.
Thankfully, there is a simple solution for all of these issues.
The easy way to force yourself to buy the dip is called dollar-cost averaging. The gist of it is that you mechanically invest small chunks of money into a stock over long periods of time, regardless of the price. Inevitably, you will buy some shares at lower prices, during dips. The point of the strategy is that it removes the element of choice, so your anxiety can't get in the way of building up a position even if you still feel it. It also forces you to maintain a longer time horizon, which is beneficial.
But unless you never look at the stock price, it's not an anxiety-proof strategy. That brings us to the harder, but ultimately more comprehensive and more effective, solution: Continually building conviction in your investment thesis over the long term. The point is to pay attention to the company's communications to investors whenever they occur.
With this approach, your research process about a company like Costco doesn't stop when you buy it the first time, or even the 10th time.
When you read the earnings updates and get a sense of how management is thinking about the business in the context of the last three months, and when you compare that information with how the stock has performed, you'll get a strong sense of whether your investment thesis is being confirmed or denied over time.
When your thesis keeps getting confirmed, if a dip comes around, you won't be anxious about the risk of buying it -- you'll be eager to get a discount on the shares of a company that you understand to be effective at what it aims to do.
Over the long run, such diligence in building conviction tends to pay off big. The icing on the cake is that you'll get plenty of time to revel in that wonderful thought we all crave: "I was right."
