How to invest when the market dipsHow to invest when the market dips

It’s normal for share markets to go up and down, but it can be hard to know if you should take action when the market dips—especially during times of volatility. 

Let’s look at some things to keep in mind when the market dips, and different ways to respond to one. 🔦

Questions to ask 💭

Can dollar-cost averaging work for you?

Dollar-cost averaging is an investing strategy that involves investing the same amount in a particular investment, regularly, regardless of the share price. This saves you from trying to time the short-term ups and downs of the share market. You might pay a bit more for your shares when the market goes up, and a bit less when the market goes down—but over time, it tends to average out. ⚖️

Here’s the deal: if you’ve been following a dollar-cost averaging strategy and your financial situation (e.g. income and expenses) and factors related to the investment (e.g. its forecast, risks, or any other due diligence considerations) haven't changed, it might assist to keep investing when the share market starts to dip. 

Otherwise, you won’t get the benefits of this approach—you’ll have paid high share prices when the markets were going up, without the counterbalance of low share prices when the markets were going down. For example, if you continue to dollar-cost average while the market is down and the market later recovers, you’ll have had the opportunity to buy shares at a lower price, decreasing the average cost per share over the long term. 

In saying that, no one can predict what’s going to happen in the share market, so it’s always important to consider what’s best for you and your financial situation.

Is your portfolio diversified?

Diversification is when you spread your money across lots of different types of investments to spread your risk—not just a mix of companies and funds, but investments with different levels of risk in different sectors and countries. 

Even in a market-wide dip, some assets, industries, or geographies may be hit harder than others. Having a diversified portfolio can help to even out the impact of a market dip across a portfolio.

Historically, share markets have eventually bounced back after every major dip. Since 1950, there’ve been 39 market corrections (drops of more than 10% from a market’s most recent peak) in the S&P 500, but the average annual return since the index was first started in 1928 through to 2021 is about 11.8%. And over the past 5 years, the S&P 500 index level has almost doubled. 

So, if you’re confident that the share market will bounce back eventually, and you have the time to wait until it does, having a diversified portfolio means you’re less reliant on the performance of a particular investment coming out of a market dip.

What’s your investment horizon?

A long investment horizon is exactly what it sounds like—investing for the long term, like ten years or more. If you’re investing for the long term, your investments have more time to ride out the ups and downs of the share market.

What about when time’s not on your side? If you’re thinking about selling sooner rather than later, ask yourself a few questions first:

• Have you met your investment goals?

• Do you need the money now?

• Are you locking in a loss?

• Are you missing out on growth?

• Or are you able to minimise your loss, instead of waiting for the share price to fall further?

Be clear about why you’re selling, and what you’ll use the money for if you do.

Actions to consider taking 💬

Reallocate your portfolio 

Some companies increase in value after coming out of a market dip. But not all of them do. Some settle at a lower value for the foreseeable future, and others go out of business entirely. 

If one of your investments is consistently sinking in value at a rate faster than the market, and faster than other companies in the same sector, then you may consider reallocating. This is when you sell your shares at a loss, and reinvest the money into something that you think might have more staying power. 

This is called active management, and it can be a tricky part of owning shares in companies. It can also be risky. You might pull out of one investment, only to have it turn around, while the one you reallocated into flatlines. That’s part of why diversification is so important—to manage the negative effects of potentially making the wrong decision when you reallocate. 

And remember, some managed funds and exchange-traded funds (ETFs) do this automatically. Fund managers have to try to stay on top of what’s happening in the market and make predictions with the information they have available. While ETFs often try to track indices (like the ASX200), if a company loses a lot of value, it might move out of the index—which may result in a reallocation within the fund! 

Look for buying opportunities

If the whole market is dipping, but you have a long investment horizon, one option could be to invest more than you have in the past. If you do this, you’re essentially saying that you expect the overall market to turn around—so you’re going to invest in that outcome now, when things are cheap. 

The upside of this approach is that you could get a solid bang for your buck. For example, if your weekly investments have fallen from a peak of $10 a share to $7 a share, and you increase your investment amount from $100 to $150, then you’re now getting 21 shares a week where you were previously getting 10. That’s twice as many shares for only 50% more investment! 

But here’s the downside: you don’t know where the bottom is, and you can’t predict the future. In that hypothetical example above, your $7 shares could drop to $5, $4, or even $1. So do your due diligence, and make sure you understand and are comfortable with taking on the extra risk. Do you have the nerves of steel you’ll need to ride out a further dip? Or are you more likely to panic and sell if things drop lower?

The reality is, we can’t know where the bottom is until it’s behind us—so if you’re comfortable with that, and you have a long investment horizon, then it might make sense to buy more shares. But if not, then this might not be the approach for you.

What about doing nothing?

It's easy to feel paralysed when the market dips, and your investing strategy is always up to you and your comfort levels. But choosing not to invest during a market dip can have its consequences. 

As we mentioned, if you’re planning to hold investments over the long term, and you choose not to invest during a market dip, you could miss out on buying shares at a lower price. Which, if the share price were to eventually go up, would mean you’d miss out on potentially higher returns.  

We say it all the time—no one has a crystal ball. There’s always a chance you lose the money you’ve invested, or lose more money by investing during a dip, so it’s important to find an investing strategy that you’re comfortable with, do your due diligence, and look for ways to manage your risk. 

Wrapping up 

Just to make things super clear here: you might consider dollar-cost averaging, diversification, and long investment horizons to ride out a market dip. You might consider looking at reallocation or buying more—but make sure you have the building blocks nailed first. And remember to always consider what works for you, your circumstances and your investing goals.