Buy or Wait? How to Decide When to Buy Stock( Part2)

You could be lucky and make the buy and sell decisions at a great time, but you typically would not be able to do this all the time over a long period. But you should not worry too much about timing the market. You can still make some good buy and sell decisions without trying to time the market. Here's how.

Dollar-Cost Averaging (DCA)

Instead of waiting for "the crash" that may or may not come, here's an idea: buy-in and if the price falls, buy some more. Instead of waiting on the sidelines or jumping all in, start small, dip your toe in and test the waters. If the tides become heavy (price falls), plant your feet firmly on the ground (buy more). Keep strengthening your feet by buying more and when the profit does come, you'll benefit heavily from this. See every "red" day as an opportunity to buy at a discount and not as a day to panic. Here's an example to explain what I mean:

Let's consider 2 different people Jack and Jennifer. They have been reading "The Beginner Investor" newsletter on LinkedIn and decided that their 2020 new year's resolution would be for them to start investing in stocks. They did their research and decided that they really liked Apple. They both had a total of $1,000 to invest. On January 2nd, they bought shares of Apple at $75.09 (using post stock split figures). The Coronavirus pandemic happened and all of 2020 went on as we know it.

9 months later, on the 1st of September, Jack and Jennifer looked at their stock portfolios and were very happy with what they saw.

The price of 1 unit of Apple share was $134.18 on this date.

Jack's $1,000 investment on January 2nd was now worth $1,786.92, a 78.69% increase.

Jennifer's $1,000 investment on the other hand was now worth $2,147.34, a 114.73% increase.

Why this difference? Let's look closer:

Jack decided to invest all his $1,000 at once on January 1st at the average cost of $75.09 for each share which gave him 13.32 shares of Apple. On the 1st of September 1, Apple share was worth $134.18, this meant that each share had made $59.09 or 78.69% and his total profit was $786.92.

Jennifer on the other hand decided that while she trusted and understood the business model of Apple, she wanted to start small with her investment. She decided to start investing at $100 and see how that went. She initially decided to continue investing $100 every month. But she noticed that the value of her investment kept going up steadily till on the 27th of February when her investment went down by 8.94% to $68.38. She saw this as a great opportunity (a Black Friday kind of opportunity) to get more shares than she did in January for the same $100. On the 9th of March, she saw the price of Apple shares fall again to $66.54, "another Black Friday", she thought, so she bought more. As the price of the share kept falling, she kept buying more. Here's what that looked like:

So, on the 1st of September, she had 16 shares (compared to Jack's 13.32 shares) at an average price of $62.49 (compared to Jack's at $75.09) which led to a profit of $71.69 on each share or 114.73% growth and total profit of $1,147.34.

What Jennifer did is called Dollar-cost averaging (DCA). This is simply the process of breaking a bulk purchase into smaller units and buying periodically. You do not always have to buy more when the price has fallen as Jennifer did. DCA can come in the form of buying on the same date every week or month. Or buying when the price has fallen beyond a certain percentage. The idea behind it is to buy in small units instead of making the purchase all at once.

Consistency is Key

To take advantage of dollar-cost averaging you can either have a fixed amount to invest every week or month and so on or when you get a lump sum to invest, you don't just buy in all at once. You could maybe break your order into smaller units and buy more when you see the price fall.

While Dollar-cost averaging is a great option to explore when investing, it also has its downside. For example, if the company's share price rises by a high amount just after you invested, you would have missed out on a great opportunity to make more profit because you did not invest all at once. In the Apple example, if the price of Apple had risen to $134.18 the next week after Jack and Jennifer invested, both of them would have had their investment increase by 78.69% but Jack would have made $786.92 because he invested $1,000 while Jennifer would have made $78.69 because she invested only $100.

The question you have to ask yourself then is, which do you prefer? The possibility of a higher return if the stock price goes up or reducing your risk and losses if the stock price goes down?

I think the dollar-cost averaging option works because if you invest all of your money and the price falls, you would not be able to buy more and reduce your cost so you would lose then. But if the price increases and you've already bought in a bit, you can benefit from those gains on the small amount you've already invested. For me, the win-win situation is with slowly buying in. But this is up to your preference.

 

While dollar-cost averaging is a great tool, also remember that it is not a substitute for doing research about companies and understanding the companies you wish to invest in. You should still study the company to understand their business model and determine for yourself if you think they would last or invest in index funds like the S&P 500. You should still think of investing and invest for the long term and all the other tips mentioned in this article

You should only adopt DCA with proven companies who have a healthy track record and whom you trust will be around for the long run. I would not recommend that you try this with a company on the edge of collapse because it's a very high risk to take. A risk that could either pay off richly or cost you a lot of money.

Final Thoughts

While you shouldn't rush to get into the stock market if you aren't learned enough, you shouldn't wait on the sidelines for the perfect time to jump in. We hardly know when the perfect time is while we are living through it. The perfect time usually becomes clear in hindsight. Here's another Warren Buffet quote for you "The sooner you get in, the better. Don't wait to buy stocks. Buy stocks and wait." Time in the market beats timing the market. You miss all the chances you don't take so waiting on the sidelines may not always be the best option in the long run.