This article is part of a series about the FIRE Movement and how investors can apply these principles to their lives, compiled by InvestorPlace.com.
Warren Buffett, arguably one of the best investors of all time, is a big believer in buying stocks when share prices fall. Back in February, on a day the markets were predicted to drop dramatically, he was telling CNBC’s Becky Quick that Berkshire Hathaway (NYSE:BRK.A, NYSE:BRK.B) would be “buying on balance.”
Buffett’s built a career buying stocks on the dip because that’s one of the best ways to make money over the long haul.
The Financial Independence, Retire Early (FIRE) philosophy doesn’t just require a commitment to cutting your day-to-day expenses; it also demands an accelerated investment philosophy.
Buffett took 60+ years to become the billionaire he is today, so if you’re dreaming of retiring at 40 when you’re only 25 today, it’s going to take more than saving 50-75% of your income to get to the promised land.
So for this article about buying on the dip, let’s assume that I’m 25 years old, earn $5,000 after-tax per month, save 50% of it, and have a $10,000 initial contribution. That gives me $30,000 to invest over a year ($450,000 over 15 years), plus the $10,000 of seed money.
With 15 years to my retirement age, if I earn 10% on my capital, I’ll have approximately $1.09 million accumulated over those 15 years. Of course, that doesn’t take into account tax-advantaged investment accounts, etc., but that’s a discussion for another article.
For now, I’m interested in providing FIRE enthusiasts with a game plan for buying on the dip that will help you achieve a 10% annual return over the next 15 years. If you can do that, you’ll be well on your way to financial independence.
What’s You’re Up Against
Before delving into the specifics of the plan, it’s essential to get an idea of how realistic a 10% return over the next 15 years really is? According to Morningstar, the SPDR S&P 500 ETF Trust (NYSEARCA:SPY) has a 15-year annualized total return of 8.89%, 111 basis points less than our target.
And that’s good news. The bad news is that many financial experts don’t expect the markets to do nearly as well in the next decade as they did in the previous one.
MarketWatch contributor Mark Hulbert has spent many years studying the markets. In February, he wrote an article that highlighted the many ways in which it would be near impossible for the S&P 500 to deliver its historical annualized total return of 6.9% (real return after inflation) over the next decade.
That means the index won’t even come close to matching its annualized real total return of 11.5% between 2010 and 2019. For many, the best days don’t lie ahead.
Taking the path of least resistance and investing in SPY isn’t likely to cut it as the rates of return for equities slow in the future.
This means if you want to get your 10% return, you’ll have to step up the risk considerably.
The Smartest Course
On the one hand, the fact that you’ve committed to saving a big chunk of your income means you’ll have the time to investigate specific growth stocks, since you won’t be out at the club dancing the night away.
However, in addition to accelerating your investment plan, you do have to remember that you can’t buy on the dip if you don’t have the cash to invest. You’ve got to remember to watch your downside by avoiding specific company risk.
Apple (NASDAQ:AAPL) is an excellent investment to own these days. But what happens if it ends up designing a phone that explodes in people’s ears? Its stock price implodes. If you only own AAPL, you have significant company risk. If you add a second stock, you reduce that risk, and so on.
It’s for this reason that I believe FIRE enthusiasts ought to use exchange-traded funds to buy on the dip. Further, I would recommend equal-weighted ETFs because it alleviates the company-specific risk of cap-weighted ETFs.
For example, the Technology Select Sector SPDR Fund (NYSEARCA:XLK) has an Apple weighting of 21.63%. It, along with Microsoft (NASDAQ:MSFT), accounts for more than 43% of the ETF’s $32.8 billion in total net assets. If you buy XLK, it’s essentially a bet on those two stocks and not much else.
The Better Way to Buy on the Dip
Don’t get me wrong; if you’re looking to accelerate your investment returns, XLK is a great place to look. However, as I said above, if those two stocks don’t perform over the next 15 years, the likelihood of reaching a million-dollar portfolio is slim to none.
So here’s what I would do.
First, I’d build a core portfolio that will deliver good, if not spectacular, returns. A little bit of defense mixed in with your offense never hurt anyone.
The Invesco S&P 500 Equal Weight ETF (NYSEARCA:RSP) is an excellent place to start. It’s an equal-weighted version of the S&P 500. It has a current AAPL weighting of 0.22%. By comparison, the SPY has an Apple weighting of 5.87%.
Also add on an international equity ETF and a small-cap ETF that charges reasonable fees. Allocate perhaps 60-75% of your permanent capital to those ETFs.
Now, to play the sector game and buy on the dip, have cash at the ready (10-30% of your total portfolio) to pounce on downtrodden sectors and industries such as energy and airlines. Again, I wouldn’t be buying specific stocks, but instead looking to benefit from the old axiom that a rising tide lifts all boats.
Throughout the novel coronavirus pandemic, I’ve been recommending investors avoid specific airline stocks. Instead, I’ve recommended they buy into the U.S. Global Jets ETF (NYSEARCA:JETS) because it allows them to make a diversified bet on the industry, rather than hand-picking one or two that could outperform the rest.
But don’t just buy JETS. Figure out how much you want to bet on airlines, use 50% of the cash you’re ready to commit to buying some shares, and another 25% when it drops by more than 3-5% in a given week. Repeat the process until you feel the bet no longer makes sense.
Oh, and whatever you do, make sure you consider one or more of the ETFs from Catherine Wood and the rest of the Ark Investment Management team. They’re in the know when it comes to technology.
Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia. At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.