Be Ready For The Dips

Includes: BLV, EDV, VIG, VNQ, VPU, VTV
by: Scott Arterburn

[Originally published on Feb. 28, 2014.]

I believe this year so far has been a good year to invest and pick up stocks that have dropped in price. From January 7th to the lowest point this year, February 3rd, the Dow Jones (DJI) dropped about 1160 points. A lot of stocks dropped quickly and some lost as much as 10% of their value. Some of these included Cummings (NYSE:CMI), Ford (F), and General Electric (GE). Since then the DJI has increased about 835 points, 5.43%. Ford and GE have rebounded past 4% while CMI has risen 18% as of 2/24/2014.

While investors were watching the dip and the subsequent increase what were they doing? Did some panic and sell? Did some buy to take advantage of the situation or were some like me, just wishing they had available cash to buy all these great declining stocks? In my situation I was not able to fully take advantage of this opportunity. I have a fault and that is I'm fully invested in the stock market. I'm a hostage, waiting for my paycheck, and don't have the freedom to invest at the price points I want to buy at. You'd think I would have learned my lesson by now as this isn't the first time the DJI has dropped by a large percent in such a short time frame.

Here are some examples of other fast drops in the history of the DJI:

  • October 1929 was the stock market crash and on that "Black Monday" the stock market dropped 10%.
  • October 13, 1989 was the savings and loan crisis. The DJI dropped almost 7%.
  • August 25th - August 31 the DJI dropped over 1000 points, 12%. This was in reaction to the Russian financial crisis.
  • April 14 2000, this was part of the Tech bubble crash. The DJI dropped 600 points, about 6%.
  • October 2nd 2008 to October 10th 2008, the DJI dropped about 2000 points. This was about 20%. This was the beginning of the U.S. financial crash.
  • May 6th 2010 was the Flash Crash. The DJI dropped 1000 points, about 9% in only a matter of an hour or two and then went back to where it was before the sudden crash by the end of the day.

More examples can be seen here, Dow Drops. After looking at all these examples, an investor can go look at the DJI chart and see what happened after every drop. They would see that it has always rebounded to a new high. It might not have been right away but it always has. Even after the most recent little drop it is only about 350 points below its all time high. I have no doubt that it will get back to that point and go beyond it.

So after this most recent drop occurred I was betting that history was going to repeat itself and was itching to buy stocks that had dropped. Two stocks that seemed cheap were AT&T (T) and McDonald's (NYSE:MCD). They dropped close to their 52 week lows. However, I still didn't have any cash; no magic genie came to grant me my wish, but there was something I could do.

Another good thing about a dip in the DJI is that not all investments drop. Bonds usually go in the opposite direction of stocks. A few Vanguard Bond ETFs increased nicely during this time. Two of them were their Extended Duration Treasury Index ETF (NYSEARCA:EDV) and their Long Term Bond fund ETF (NYSEARCA:BLV). They increased about 12% and 5% respectively. I owned both and thought I could to take advantage of this and sell into strength so I would have some cash to invest in other investments. However, selling them would cause two problems. One, I was holding them for the long term. They seem safe and yield over 4%. Second, selling them would have tax implications.

I weighed the pros of cons and decided to sell half my stakes in BLV and EDV. That gave me some cash. I then had another decision to make. What should I invest in? There were lots of options to choose from. There were a lot stocks in different sectors going down. Since I didn't have much money to work with and I could save transaction costs by buying Vanguard funds, I decided to buy a handful of Vanguard ETFs. Some of these included Vanguard's Utilities ETF (NYSEARCA:VPU), Vanguard's Dividend Appreciation EFT (NYSEARCA:VIG), Vanguard's REIT ETF (NYSEARCA:VNQ), and Vanguard's Value ETF (NYSEARCA:VTV). Most of the funds I have bought have increased between 2%-4% with VPU up past 8% since the drop.

I was able to take some advantage of the downturn in the market. This didn't come without costs. I had to give up some investments that I wanted to hold long term and now will have to pay taxes on those sales. The good news is that EDV and BLV have been on a downslide since Feb. 3rd when the market starting climbing back up. EDV has dropped over 4% so I can get back into it at the price I originally paid for it.

There is another side to this story. There are some financial experts who think investors shouldn't buy into dips. There was an article that came out at the end of February. It is entitled Never Buy the Dips written by Jeff Macke. Jeff writes about investor Jonathan Hoenig, whose video suggests that an investor should never buy into dips. He thinks an investor shouldn't buy any stock that goes down in price because the stock could go lower. He seems to think that any stock that drops must be a bad stock/company to invest in.

I would have to disagree. There is no premise that stocks that drop are bad stocks. Stocks go up or down every day and no one can predict that. My article doesn't suggest that an investor should go into a buying frenzy and buy every stock that went lower. I am simply saying that if an investor is holding on to a stock, like CMI, for the long term and it drops 10%, why not buy more if they have good financials and you believe in it? If an investor has been watching a stock for months and it suddenly drops and there isn't a good reason for it, this could be a good entry point to start investing in it. It's a good thing to have cash ready stocks fall fast. Hoenig is 50% right. A stock could go lower even after you buy it. However, I am of the mindset of investing for the long term. If the fundamentals of a company haven't changed and there was no bad news to that specific company, an investor may not mind if it still drops lower. It might be a better opportunity to buy more if it does or just hold on and wait to see what happens. That's why you just don't buy into your whole position all at once. History speaks for itself, the DJI has always gone on to new highs after a dip. There will be some stocks that won't make it through in troubled times so every investor must keep current on their research on all current and future holdings to make sure they are still worth the risk.

I have finally learned my lesson, which is to not be fully invested. I have increased my cash reserves by 10% so that I can take advantage of days when stocks drop quickly. It's much easier to invest with cash that is waiting on the sidelines than having to sell other investments, borrow money, or just do nothing because I have no cash on hand. Hopefully this article will make other investors who are also fully invested to rethink the way they invest.

Disclosure: I am long EDV, BLV.