When Buy The Dip Stops Working

When "Buy the Dip" Stops Working

Since 2009, investors have experienced the same pattern over and over: the market climbs, pauses or dips, then climbs again. Seventeen years of repetition shapes expectations. Every dip starts to look like an opportunity. Every recovery feels inevitable. At some point "buy the dip" stops being a strategy and starts feeling like, “That’s just how market works.”

That assumption will hold . . . until it doesn't.

Most investors know that markets can fall. They've read about bear markets and maybe even studied some market history. Some even lived through 2000 or 2008. But if you haven't experienced a long, grinding decline in your working years, the concept stays theoretical. You know it happened, that it could happen again but it just seems like something from another era.

When knowledge and experience diverge, experience naturally wins. When that experience contains only one kind of market decline, it introduces a different kind of risk. You prepare for what you’ve seen. You don’t prepare for what you haven’t.

Market history includes outcomes that recent years don’t suggest, including periods of deep loss that took years, and in some cases decades, to recover. Prolonged declines affect behavior in a different way. Pressure builds slowly, patience gets tested in ways that short declines never touch, and decisions wait until they can no longer be delayed.

The difference becomes clearer when you compare recent history with a longer view.

Market Declines Over 5%

Source: Author, shillerdata.com

You can see that the average decline size hasn't changed much since 1900. Recovery speed has. In recent years, declines have come more often and resolved much faster. This pairing matters.

Frequent declines create opportunity. Fast recoveries reinforce the decision to act. This pattern teaches investors to expect weakness to pass quickly. Based on recent history, that expectation looks reasonable

Such an environment has helped produce two tendencies for lagging preparations for its ending.

• First, we discount what we haven't experienced. If something hasn't happened recently it doesn't demand our attention. It sits in the background as theoretical risk.

• Second, we delay action until the need becomes visible or even unavoidable. Preparation requires some effort and carries a cost. Conditions that feel stable make preparation efforts and costs seem unnecessary.

Over time, these tendencies drift further. Urgency fades. The cost of acting increases. Options narrow. Flexibility declines. By the time action feels absolutely necessary, conditions will have changed, perhaps dramatically.

You can probably tell that investing holds no special lock on this pattern. You notice it across human behavior. Let’s look at one example area.

Theoretically, preparation for hurricanes should start before the storm season even starts for those of us in the southeastern part of the US. Supplies remain plentiful. Prices stay stable. Actions need no rushing. Decisions happen calmly.

In reality, however, many (most?) people wait. I certainly have. As a major off shore hurricane was making a beeline straight towards the NC outer banks a few years back, I decided that we really needed a gas powered chainsaw for storm cleanup. Our electric chainsaw wasn’t going to cut it (pun intended) if the hurricane hit us hard. I checked big box retailer inventories online and watched in real time as lower priced saws dropped and disappeared. By the time I acted, stores only had a few expensive models. Neither the stores nor the tools had changed – just the timing.

Investors behave in similar ways. Many wait for clear signs of danger before taking protective action. By then, however, flexibility has faded.

Preparation Timing Gap

Source: Author drawing

The cost of acting early on stays low but the need to act feels low as well. Both rise over time though cost climbs all along. Meanwhile, urgency stays low. It accelerates late in the process. It takes off late in the process – like when the red flags are flying at the coast. Urgency finally drives action though it may be too late to execute effective preparations.

Preparation doesn't require any prediction. It just requires decisions made in advance.

When recoveries come quickly as they have in recent years, a deep or long-term bear market will present new challenges for many people. Most investors assume they'll stay disciplined during a downturn. Perhaps, but how many have tested that assumption under prolonged pressure – either with some math or with real life experience?

One way to prepare: define decisions ahead of time with a systematic approach. It sets paths before conditions change. It removes the need to react and decide in moments of stress. The advantage doesn't come from predicting what will happen but from having already decided paths for various scenarios – especially stressful ones.

The risk for a deep bear market or a long-term one doesn't stick out today and that's the challenge. Recent experience has been favorable and consistent to investors who have held through or bought every dip. That has shaped expectations in ways that feel justified. At some point, the pattern will shift. When it does, habits built up in one environment won't carry well over to the next.

The time to prepare for that shift doesn't arrive when it becomes obvious, like when the red flags are flying at the beach. It starts on sunny days – like today.  

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