Buying in crashes
Crashes are opportunities — but the extra money should come from new income, not cash hoarded while waiting for a crash.
In One Sentence
Keep investing a fixed amount every month as usual; when the index falls more than 20% from its high, use new income to buy some extra.
Why It Matters
For the market as a whole, the margin of safety is widest when everyone is most afraid. The money you add should come from a year-end bonus, a raise or a trip you decided to skip — not from cash you've deliberately kept on the sidelines waiting for a crash. My backtests show that approach doesn't do any better.
One Number
Investing double in months when the market was down more than 20% left each dollar's final wealth about 20% higher in the US and about 10% higher in Taiwan than plain dollar-cost averaging — but 11% to 15% lower in Japan (author's backtests · Chapter V).
In the Book
Chapter III uses mean reversion to conclude that a big fall is an opportunity. Section 3 of Chapter V uses backtests to show how to add more. The thermometer in Chapter VI only describes how cold or hot the market is; whether to add more depends on whether you have new income.
Go Further
- Mean reversion Prices that fall too far get pulled back over time — that's the reason to add more.
- Bubbles Right after a bubble bursts is often the time to add more.
- "Sell when pricey" backtest I replaced "sell when pricey" with "add more in crashes."
- Global diversification Japan took 34 years to get back to its high, so it's best to spread across the whole world.
- Borrowing and leverage Add more only with spare money, and never borrow to do it.
- Dollar-cost averaging Adding more sits on top of dollar-cost averaging; it doesn't replace it.