Let’s assume that you have a ton of cash sitting in your investment portfolio, and you want to do something with it. What should you do? Maybe you’ve decided to buy stocks or gold/silver.
Whatever you choose to do, the important thing is to buy at a good price. Making sure that your market prediction (bullish or bearish) is right isn’t the only important thing. You also have to buy at the right price.
In this post, I’m going to explain two ways that investors use to enter a market. These two methods are used during different circumstances. Which method you should use depends on what the market stage is at the moment.
Buy it All
This is the method of entering a market that most people use. They identify a price that they would like to buy at, and once the market hits that price, they put all of their money into the market at the then-market price.
Here’s an example. Let’s assume you want to buy SPX, which is the ETF for the S&P500. Currently SPX is trading at 1650. You currently have $20,000 in cash that you would like to use to buy SPX. You set an order (in your brokerage account) to buy $20k worth of SPX the instant SPX hits 1600. Thus, your order is 100% filled at once.
The “buy it all” method is most suitable for when the market is close to a multi-year bottom. Such a bottom would include the March 2009 bottom in stocks and the recent bottom in gold and silver. It is not well suited for a “buy on the dip” situation. Why?
Because when you “buy on the dip”, the “dip” is typically a 10% correction. HOWEVER, there is always the possibility that a 10% correction will magnify into a 20% correction, meaning that you did not buy at a cheap price. During a correction, it’s best to average in (which I will explain later).
Towards the bottom of a massive bear market, you know that the market will soon bottom out. All the technical indicators have reached their extremes, and the market is way oversold. You know that the bottom is coming soon, but you don’t know exactly how many days. Thus, the best thing to do is just dump all your money into the market and Hail Mary it. It doesn’t matter if the market falls another 5% before it bottoms out. In such market extremes (close to the bottom of a bear market), almost no one can perfectly catch the falling knife. All you can do is get close-to rock bottom prices.
Some investors really don’t like to average in. In case you don’t know what this is, “averaging in” means to buy a portion of your position on the way down when the market falls. When the market falls, you might choose to enter 1/4 of your cash into the market at increments.
Here’s an example. Let’s assume that you have $20k of cash you want to invest. Every 3% that the market falls, you’ll buy $5k worth of stocks. That’s what “averaging in” means. You’re “averaging” the average price that you bought your entire position at.
Personally, I find that averaging in works best when the market is experiencing a correction (6-15% decline). Corrections are normal waves in a bull market. Why average in instead of just putting all of your cash into the market at once?
Because you don’t know how far this market correction will go. I know that it’s a range: 6-15%. But let me tell you, that’s a pretty big range. If you put all of your cash into the market once it falls 8%, it might fall another 5% and then you’ll be kicking yourself mentally.
Instead, what I choose to do is average in. Every 3% that the market falls (after it falls 6% already), I put a quarter of my cash into the market. That way if the market only falls 6%, I’ll have bought at rock bottom prices (although my position would only be a quarter filled). If the market continues to fall, I’m better off by averaging in (because my average price is lowered) than if I just dumped all my money into the market once it fell a mere 6%.
Thanks for reading! I’m Troy from The Financial Economist. Cheers!
This was a Guest Post from Troy at The Financial Economist