26 July 2007

Is buying on a down day market timing?

I'm making a Roth IRA purchase today, and I'm not ashamed to admit that it's because the market took a dive today. I am not a believer in market timing, but if I can snatch an extra 2-3% simply by buying while prices are down . . . I'm going to do it.

Reading across the web, in forums and blogs, I've seen a lot of criticism of this practice, with the True Believers of the Efficient Market lecturing others that they should be watching prices to decide when to buy. I think that this is pretty crappy advice, and that it can cost people money in the long run. Here's a quick look at what happens to your money when you buy during a dip vs. the day before.

Suppose that I have $1000 to invest in VBR, Vanguard's Small Cap Value fund. Also suppose that from yesterday to the end of the year, VBR is destined to rise 2%. It looks like VBR is going to shed about 3% today, providing a discounted purchase price. What's the difference between buying yesterday and buying today?

Yesterday, VBR closed at $72.64, and the current price is $70.26, a drop of 3.28%. $1000 yesterday would have bought me 13.77 shares. At the current price, I can buy 14.23 shares. Under my assumption that VBR would grow 2% from yesterday to the end of the year, the year-end price will be $74.09.

  • If I bought yesterday, at the end of the year my 13.77 shares would be worth about $1,020.
  • If I bought today, at the end of the year my 14.23 shares would be worth about $1,054.
We're all frugal here in the PF blogging world. If I told you I could get you an extra $34 you'd be excited about it, right? So why are we made to feel guilty for buying on a down day in order to squeeze a little more out of the market?

Is this market-timing? Sure it is, in some ways. But we're not changing our allocations based on timing, we're not selling any stocks based on timing . . . we're merely making a decision on when to buy based on the status of the market.

Now, naturally, there is a problem with this. If you made all of your buying decisions based on this, you'd make some mistakes. Some months you're not going to see a 3%, 2%, or even 1% loss in the market on a given day. So waiting for that dip can cost you valuable gains, especially if you choose not to invest that month at all. There is no predicting this sort of thing, so counting on a down time in which to buy is a mistake.

However, buying doesn't have to be either/or. To some degree you can have your cake and eat it too. If you normally invest at the end/beginning of the month, but on the 26th the market drops 3% . . . go ahead and dive in early. Is it possible that prices will actually be lower a few days later? Sure, but often these dips regulate the market and it will rise in the following days. If you get to the end of the month and you haven't seen a dip in which to invest, just throw it in at the end of the month as you had previously planned. You're not keeping money out of the market unnecessarily, you're not pulling funds out . . . you're just taking advantage of an opportunity and investing a few days early.

I see no problem with this, and I think most people would agree. In the long run I think this strategy will make you more money than simply investing on the same day each month . . . but clearly others have a different opinion. What say you, readers?

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