Why People Fail With Investing
Fear and Greed
Buying the ‘dip’ can be a good strategy with investing. The problem is the ‘Fear and Greed’ that investors are continually faced with. You see your investment rise over time and hold expecting further rises. We have no real exit plan to lock in those gains.
Greed kicks in as we see it collapse 20%. It recovers the next day 5%. We think OK it is on its way back now; then Wednesday it dumps another 15%. Now we are consumed with fear and see a 30% drop in 3 days. Will it drop further or will it recover?
We now have 3 choices
1 Buy more?
2 Sell all (or some) our holdings?
3 Hold (do nothing)?
Most people choose option 2, hence we lose the gains and are left holding some red bags. If we hold, we have no certainty that the price can recover.
With an exit plan this should not happen. If we see 5% or more gains we should consider starting to take profits off the table. Maybe 25% for every 5% gained would be an option. Better to sell out of a position with a profit now, than later see it melt away like ice in the midday sun.
Option 1 ‘Buy More’ is the perhaps the least well used option, but perhaps the most powerful. This requires the investor to always have funds available to take opportunities of market corrections when they occur.
‘Buying the dip’ is an investment thesis often touted by traders and financial advisors to juice returns. The thinking is: When a stock index like the S & P 500 falls in value, it’s a good time to buy since shares can be bought at a discount. Investors then reap the financial rewards when stocks rebound.
Imagine you want to buy a new car at £30,000. You save for the car and want to buy in cash. Despite all your attempts to get a cash discount from the dealer, the best you can do is 5% and a free tank of petrol. You buy the car. A month later you see the same model advertised at a 20% discount as a newer model is coming out. Now you are driving around in a car you paid £28,500 for and you could have bought it for £24,000. Time is everything and this scenario is no better seen than in the markets.
When we see the price of Bitcoin rising fast, instead of having an entry plan, we experience fear of missing out (FOMO) and buy high. The following day it corrects 10% downward and we are filled full of regret at not waiting for the lower price. However, using an automatic laddering in our total position we can pretty much eliminate this problem.
Using DCA (Dollar cost averaging). (Email me about an automatic approach for this.)
Just to be clear we need to buy low and sell high.
CNBC explain ‘buying the dip’ as below:
The Dow Jones Industrial Average stock index tumbled 2.1% on Monday, (its worst day since October), on investor fears about the COVID-19 Delta variant. However, the market rebounded on Tuesday, with the Dow closing 1.6% higher.
Americans have received ‘stimulus cheques’ over the past 18 months.
“All of that cash is looking for somewhere to go,” said Dan Egan, Vice President of behavioral finance and investing at Betterment. “When there’s a big dip in the market, this is a good use of that windfall.”
Investor psychology may cause an urge to sell, rather than buy, when the market pulls back. Unfortunately, that impulse will likely cost them.
An investor who put $10,000 in the S&P 500 at the beginning of 2001 (it stayed invested) would have turned it into $42,231 two decades later, for a 7.47% annual return, according to J P Morgan Asset Management. However, an investor who pulled out and missed the 10 best market days over that period would have just $19,347, (a 3.35% annual return), J P Morgan pointed out.
Investors who buy during a market dip should know stocks may continue to fall before they rebound. This is why averaging in your position is important where the net entry point of your investment gets lower as the price continues to dip.
“Just because you waited for it to go down 10% doesn’t mean it can’t go down 20%,” Egan said.
Investors will have the most success with the strategy if they’re already executing an investment plan and have a little additional cash set aside for opportunistic investment.
Investors can take a more regulated approach by executing the piecemeal strategy. If an investor has $10,000 in cash, the person can invest $2,000 at a time whenever there’s a 2% or 3% selloff, instead of all at once.
This averaging in strategy is powerful when done automatically and later we explain how robot with ‘3commas’ can do this.
By averaging in your investment, if the price drops your average entry price becomes much lower over time and therefore significantly greater gains are realised once the price moves higher. If the price continues to climb we still benefit by laddering in our position and riding the upswing. Remember however that the wealthiest people are dead! These are the ones who invested many years ago and have since died. The fund or investment is discovered years later, to find that since the investment the price has seen massive gains over time.
The message here is that ‘time in the market’ is worth far more than ‘timing the market’. If your time horizon for investing is 4-5 years, this ‘holding’ approach in the case of Bitcoin will always generate significant returns if Bitcoin’s history is anything to go by. In reality, if the time frame is long enough, doing nothing is perhaps the best option. Second best is buying more on the dip and the worst option for the longer term investor is selling out. The last option sadly is the one most people adopt.
For more information about my own approach to investing get my free Ebook at firstname.lastname@example.org
Be aware that as with all investments, prices can go up as well as down, so only invest money you can afford to lose.