Is it better to buy before prices fall?
Conventional wisdom says “Buy Low, Sell High.” If the goal is to trade, to make money by buying something now to sell it at a profit later, then yes, buying low is better. The lower you buy and the higher you sell means a greater profit. But that is not the only way.
If your goal is to provide income from dividends, then buying at the absolute low means one can miss out on some important opportunities.
Of course buying at the absolute low means that dividends will be buying additional shares as the share price increases. As the share prices increase, one buys less and less shares.
So let’s look at this another way. (We touched on this thinking in a post during the March 2020 stock meltdown.) Let’s start before the absolute bottom. Let’s say that prices are stable, then decline to a bottom, then increase again back to a stable price.
If we purchase only at the bottom, then we have a set of shares that increased in price. But we miss out on half the opportunity.
But if we buy prior to the decline, then we have more shares: some acquired as the price declined, then some at the bottom, then some as the share price increased.
So having shares prior to the decline means we will likely have many more shares, and many at the discounted (lower) price all compared to the final “stable” price. And since the average prices of shares acquired during a decline is lower than the final “stable” price, we have then acquired more shares at a lower average price than we would have normally done if we only started buying at the bottom.
A Visual Example
The following graph displays a hypothetical case of a stock’s price in a decline and then in an advance. For sake of this example, each data point on the graph signifies the price of the stock at the time of its quarterly dividend, which in this case is over a period of 11 quarters.
If, for example, you purchase a stock at the low, which in this case is at 1, your dividends will buy additional shares or parts of shares, at 3, 5, 7, and then 10. Which means you are purchasing additional shares at increasing prices. While your dividend income increases because you own additional shares at each dividend, since you are also purchasing as the price is increasing, you will not accumulate as many shares as one could.
However, if we own shares before the decline, at the price in the example chart of 10, on the left side, our dividends purchase an increasing number of shares at each declining price level. We accumulate the maximum number of shares at the lowest price, which in this case is 1. Then as the price increases, since we have accumulated a larger number of shares, our dividends continue to buy more shares. Despite the increase in price, our holdings increase as well.
Of course this is a hypothetical example. No stock declines and advances in such an orderly fashion. But it does illustrate a powerful lesson in buy and hold dividend investing.
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