What if buy the dip stops working?

We’ve seen a bit of a wobble across financial markets this last week or two.

Tech stocks have fallen in the wake of hot inflation, rising bond yields and no sign of reprieve from stubbornly high oil prices.

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Questions are also being asked about companies overspending on artificial intelligence, and a potential memory chip glut as South Korea faces competition from China.

This could turn into a bigger sell-off or the volatility might blow over quickly. It’s impossible to say.

Either way, it’s a reminder that the winds can change quickly and that markets won’t keep rising forever.

For many investors, the response to any setback has become almost automatic. You buy the dip.

That’s been a rewarding mantra, particularly for those who started investing after the global financial crisis.

But what happens if this approach stops delivering the quick reward we’ve become accustomed to?

What if the initial fall is followed by another, and if the recovery takes years rather than months?

That would put many investors in unfamiliar territory, and it would test their resolve.

Someone turning 40 this year was only 22 in 2008, when US investment bank Lehman Brothers collapsed during the global financial crisis (GFC).

That era was accompanied by a deep recession, with job losses and business failures adding to investors’ anxiety.

The S&P 500 in the US fell 56.8 per cent from its October 2007 peak to its March 2009 low.

It was a decline lasting 17 months, followed by another four years before the index regained its previous high.

That meant roughly five-and-a-half years just to get back to where it started, excluding dividends.

Many younger investors have never experienced anything like that with their own savings at stake.

To be fair, the GFC was the biggest sharemarket decline since the Great Depression in the 1930s, so it’s an extreme example.

However, if you started investing in shares after 2009 your world view has been shaped by a period when market setbacks have generally been shallower and shorter.

I looked back at all the S&P 500 declines of ten per cent or more since 1960.

Across the 25 falls through to the GFC, the average decline was 21.5 per cent and lasted 8.2 months.

Since then, and excluding the COVID decline of 2020, eight declines have averaged 16.7 per cent and lasted just 3.6 months.

The COVID example deserves an asterisk.

While the economic damage and investment losses were real, the shutdowns and extraordinary policy response made it an unusual episode.

The market plunged 33.2 per cent, but was over in just 33 days so investors barely had time to panic and sell.

The bounce that followed was swift and sharp, and the S&P 500 regained its previous peak within about six months.

That’s very different to a prolonged downturn where losses deepen, apparent recoveries fail and confidence gradually drains away.

Even a strong rebound doesn’t necessarily repair the damage, and a market that halves needs to double just to get back to where it started.

Buying during those episodes will still work for patient investors, but it requires more financial capacity and much more emotional resilience than taking advantage of a brief correction.

That’s why the business cycle deserves respect, even when activity and earnings look healthy.

Since the 1980s, US economic expansions have grown longer and recessions less frequent.

Structural changes to the economy could mean that continues, but another recession or crisis will eventually arrive.

Recognising that doesn’t mean one is imminent, or that investors should retreat to cash and wait patiently for the storm clouds.

It means preparing while the going is still good, and getting your mindset right.

Keep money you might need soon out of the sharemarket, diversify widely and ensure your debt levels are in check.

Hold enough liquid, accessible funds to avoid ending up as a forced seller at depressed prices.

Most important of all, ask yourself whether your confidence would survive a recovery measured in years, rather than months.

Younger investors have time on their side, which is a massive advantage.

It means you can take more risks, so take your opportunities and don’t be afraid of buying all those dips.

Just make sure you’re realistic about what might follow, because knowing about past bear markets is very different from living through one with your own savings invested.

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