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An investor who “buys the dip” might take advantage of market volatility or short-term events to ideally get a better return on investments. While timing the market and individual equity investments have their own risks, buying the dip can be a good way to invest in good assets while they’ve temporarily lost value. For example, in early 2020, the stock market took significant losses due to the coronavirus pandemic. This pulled down the value of almost all equities. Many investors took advantage of that, staging a rally within three months of the downturn.
Even high-flying companies were affected, though. For example, take NVIDIA, one of the most valuable stocks on the market. Say that you had invested $1,000 in NVIDIA stock at the trough, what would you have today?
A financial advisor can help you create a plan and identify buying opportunities.
NVIDIA in the 2020 Dip
So, what would have happened if you had bought NVIDIA during the dip?
On February 19, 2020, NVIDIA hit its pre-pandemic high at $7.83 per share. During the Covid recession, NVIDIA’s share price dropped to a low of $4.89 per share.
Say that you had invested $1,000 at that low point, you would have 204 shares of NVIDIA stock ($1,000 / $4.89).
Now, NVIDIA’s stock sells for around $135.40. Your shares purchased in 2020 would be worth $27,621.60 in total today (204 shares * $135.40 per share).
Some readers will note that NVIDIA’s stock has split twice in the years since, first 4-1 and then 10-1, so investors will actually own 40 shares for every one that they bought five years ago. While this is true, stock charts are adjusted to reflect splits. In other words, if you had invested $1,000 in NVIDIA stock at the actual price in February, 2020, you would have likely purchased around 5 shares. Then, after multiple splits, you would hold 204 shares worth $27,621.60 today.
This would have been a strong example of speculatively buying the dip. Buying any individual equity is speculation, but like most of the market NVIDIA’s decline was due to market factors outside the company’s control. As a result, investors could buy in with a reasonable belief that the company’s underlying fundamentals would lead to a rally.
For help evaluating NVDA and other potential investments, consider speaking with a fiduciary financial advisor.
What Is Systematic Risk?
There are two kinds of risk when it comes to investing: systematic and unsystematic.
Unsystematic risks refer to issues specific to the asset itself. In the stock market, this means any factor related to the underlying company. A business plan, for example, or corporate leadership refer to unsystematic risks. If, for example, a company’s product turns out to cause an illness, or, on the other hand, if investors favor its new CEO, these factors can affect that company’s stock price without necessarily impacting the price of other firms.
Systematic risk refers to issues that affect an entire market or economy at large. Taxes and local laws are two common examples of systematic risk. Every company that operates in a country is subject to its laws. So if, for example, the government imposes high taxes in the form of tariffs or issues broad economic stimulus, these factors can affect the stock price of every domestic firm.
Market downturns are considered a form of systematic risk. Whatever sets a downturn in motion, once a bear market is started, it tends to drag down the price of most (if not all) traded stocks. Firms that had nothing to do with housing, for example, still lost value in the 2008 recession, just like companies beyond service and hospitality all lost share price during the 2020 Covid lockdowns.
Systematic Risk and Buying the Dip
Buying the dip, as noted above, refers to the practice of buying assets after they’ve dropped in price. When this practice works, it allows you to invest in undervalued assets while they’re temporarily depressed, capturing the gains when prices recover.
However, as the Encyclopedia Britannica notes in its article on the subject, other side of this advice is “never catch a falling knife.” This refers to the idea that you shouldn’t buy something just because it’s cheap. There might a reason everyone is selling this asset, so you might not want it.
Systematic risk is often a way to reconcile these two ideas.
When a systematic event depresses share prices, it means that assets have lost value for reasons unrelated to the asset’s fundamental value. Now, this external factor may ultimately shift the asset’s long-term value. For example, say the government passes a series of new laws that change the business environment. If those laws remain in place long term, they can change the value of different firms based on their ability to operate under these new conditions.
However, during a market downturn, losses tend to take on a momentum of their own. Investors sell because people are selling, which means that share prices often reflect the state of the market rather than the state of the underlying firms. In that case, many stocks will be undervalued. This can be a good opportunity to buy the dip.
This is why financial professionals can advise a version of buying the dip that avoids timing the market. The two ideas, after all, do overlap. To buy the dip wisely, they might recommend sticking to your current financial strategy, just funding it more generously during a downturn. (Of course, you can always speak to a financial advisor about whether changing conditions warrant changing your financial strategy.)
This often involves buying the assets or categories of asset that you ordinarily buy, holding your assets according to your existing timelines, and in general following the same plan that you have in place. Just, in this case, you would in theory put some extra money into that plan. If you have extra cash on hand, you might choose to increase your contributions to your portfolio(s) during market downturns. That way, you would still be buying assets that you consider to be smart, just purchasing while they are likely undervalued.
Bottom Line
Buying the dip is a practice of investing in assets when they are currently depressed. While it can be a speculative practice, when systematic risk has triggered a market downturn this can be a wise way to accelerate your long-term savings plan.
Tips on Analyzing Undervalued Assets
- A financial advisor can help you build a comprehensive retirement plan. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- How exactly can you spot an undervalued stock? There are many different factors that can help you decide that a company has strong fundamental value, even if it’s currently oversold.
- Keep an emergency fund on hand in case you run into unexpected expenses. An emergency fund should be liquid, in an account that isn’t at risk of significant fluctuation like the stock market. The tradeoff is that the value of liquid cash can be eroded by inflation. But a high-interest account allows you to earn compound interest. Compare savings accounts from these banks.
- Are you a financial advisor looking to grow your business? SmartAsset AMP helps advisors connect with leads and offers marketing automation solutions so you can spend more time making conversions. Learn more about SmartAsset AMP.
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