Does waiting to buy on dips work?

One of our esteemed investors recently shared an SIP investment strategy and asked us to evaluate it. The strategy is simple and sounds logical on the face of it - instead of investing on a fixed day every month, wait for a day when the markets are down (say by 2%) to invest, thus giving the investor a sort of 'low' price of entry as compared to a random price that the fixed day SIP would have given him.

Sounds like a plan. But does it work and if it does, how much will the difference be between the two methods?

In order to analyse this strategy we also need to decide what happens if there is no day with a 2% drop in a particular month? Do we then invest on the last day of the month irrespective of the price or skip that month altogether and wait till we get a 2% down day, however many months that may take? Let's analyse both the cases.

Case a) For every month, invest on a day when the markets is 2% down. Invest on the last day of the month in case there is no 2% down day throughout the month

Let's compare our 'triggered' SIP to a simple one where we invest on the last day of the month every month.

The difference between the two will happen only in months where there is a 2% down day. So the question now becomes that in such months, on average, is the price at the end of month higher or lower than the price when there was a 2% fall?

If it is higher, then our triggered SIP is better as it gives a lower price of entry on average for such months. If the price is lower at the end of the month, then the end of month SIP is better.

The answer?

We looked at the historical data for close to 20 years since the second half of 1997. There have been 231 months in total out of which 137 months had at least one day when the stock markets were down 2% or more. That's about 60% of all months - enough to make a difference if there is one. The rest 40% of the months did not have a single such down day.

What happened to the stock market prices after they fell 2% on a day?

In about half of the cases, the prices were higher by the end of the month (prices bounced back) while in the other half, the prices were even lower by the end of the month (prices kept falling). On average, the price at the end of the month was the same as that on the day of the fall.

Two recent occurrences also bear this out:
On June 24, 2016, Nifty closed at 8088.6, down from 8270 - a fall of about 2.2%. By the end of the month, the Nifty was higher at 8287.

The next such day occurred on Sep 12, 2016. Nifty closed at 8715.6, down almost 2% for the day. By the end of the month, it was even lower at 8611. So if you had just waited till the end of the month you would have gotten a better price.

On average, it did not matter whether you rushed to buy it immediately after the fall or waited for the end of the month. In the long term, the higher and the lower cases got averaged out and the end result was approximately the same. The effort and time spent in executing a triggered SIP does not seem to add any benefit over a normal SIP.

Case b) Invest only in months when the markets is 2% down. Skip months and wait for a 2% down day however long that may take.

This is the more hard-liner approach. Instead of investing every month, we only invest in months when there is a 2% fall (60% of all months) and we skip the rest of the months (40% of all months).

We saw while analysing case a) that the price at the end of the month is same as the price after a 2% fall on average. Hence this investing strategy is equivalent to investing at the end of the month in months when the markets have a 2% down day and skipping the rest of the months.

Does this work?
Unfortunately not. And not only it does not work, it is actually much worse.

The reason should be obvious by now: The skipped 40% months that don't have any such down day have positive returns i.e. the prices rise while we wait. And in fact they rise by more than they do in normal months (3% vs the usual 1%) - because these are the months which don't have a big negative day! So by the time the next dip comes, the prices have already increased by a lot.

This is also borne out in the recent examples mentioned above. After June 2016, the next 2% dip came in September 2016 by which time the Nifty had already moved from 8088 to 8715!

So 'buying on dips' might be the go-to mantra of the talking heads on TV or of your friendly neighbourhood mutual fund distributor but it seems more like a marketing gimmick meant to make them sound smart rather than a strategy that actually works. This is especially true if you are investing for the long term and not just trading for gains of 4-5%.

In the end, remember this from a Nobel Laureate and legendary investor Paul Samuelson,

"Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas."