How Should I Buy?

It is wise to ask: How, How Much, When

Many want to invest. Of course, they want to buy investments at the right price and time. But they fear the timing of their entry into the market or into specific stocks or ETFs. The reasonable questions include: 1) When should a buy order be placed? 2) How much should I buy of any one investment? 3) Should I buy all of what I want in a single buy limit order? One of the fundamental questions, I believe, is: “How should I buy a stock or ETF?”

How Should I Buy a Stock or ETF?

The Swimming Analogy

When I was a  boy, and my brother Russell and I went to the Centennial Pool in Naperville, Illinois in the 1960’s, there were four ways to approach the water. 1) Dive in; 2) Wade in; 3) Touch the water with a big toe or 4) Stay on the beach and look at the water. How should I enter, or should I wait?

I took swimming lessons at the pool. Getting into the deep end was frightening, until I learned how to swim. The same is true of investing. I’m no longer afraid of diving into the market, but I dive in thoughtfully when I decide to dive. I don’t want to dive into shallow water. Sometimes wading in is a far better approach when there are a lot of waves.

Wading Into Investing

Some Seeking Alpha authors have the ability to share investment wisdom that is rich in practical ideas. One such writer wrote a piece called “The Art Of Not Selling” and another titled “5 Ways To Buy A Stock That Will Make You Rich (Very Slowly).”

In the former he said, “Great long-term investing is 1% buying, 99% waiting.” I agree. In the second he said “The way you invest matters more than what you are investing in” and “If you have found a fantastic company you are ready to add to your portfolio, the real question you should ask is not whether you should buy it, but how you should buy it.” (LINK)

He then went on to talk about different buying strategies. The five he suggested were: (LINK)

How to Buy

1) Dollar Cost Averaging

2) Averaging Up

3) Adding On Selloffs

4) Adding At A Lower Valuation

5) Dividend Reinvestment Plan

Because his article is more than 2,500 words, the average reader of my blog won’t read it. Let me give you the “Wayne’s Notes” version.

Avoid the Extremes

First of all, avoid the extreme temptations that say either, “If I don’t dive in and buy everything today I will regret it” and the other one which is “I think I will wait another day to see what the market is doing tomorrow, or next week, or couple of months from now.’ The first approach is rash and the second is paralysis. A general truth about haste is something we have all experienced. “Desire without knowledge is not good, and whoever makes haste with his feet misses his way.” Proverbs 19:2. Far too often I rushed to do something, and my lack of caution led to a fall.  Delaying or procrastination are also generally foolish as well. Proverbs 6:10-11 says this of the folly of delaying efforts: “A little sleep, a little slumber, a little folding of the hands to rest, and poverty will come upon you like a robber, and want like an armed man.”

Add shares slowly but methodically

All five of the buying strategies are similar, but the first three require action. They are: 1) Dollar cost averaging, 2) Averaging up, 3) Adding on selloffs and 4) Adding at a lower valuation. Think for just a moment. These four require that you have cash available to buy more of what you already own. Therefore, if I have $10,000 to invest, rarely would I want to invest all of the dollars today. I’m not going to talk about each of these, but the idea is that you might be buying at a good price at $50, but next week the price might be $49. If I buy 10 shares this week at $50 and 20 shares at $49 the next week, my average cost for the 30 shares is $49.33 per share.

Did I miss an opportunity?

You should ask the question, “but what if the price in week two is $51?” That may be a clue that other buyers think the investment is a good investment, so demand is picking up and supply doesn’t meet the demand at $50 per share.  Do I now panic and buy shares at $51/share with my remaining investment $8,520 dollars? No, but I might buy another ten shares at $51. That is called “averaging up.” The author I mentioned above has the following to say about “Averaging Up.”:

Averaging Up

“Averaging up is the concept of adding to a position that has already appreciated. By doing so, you are driving up the average cost of your position by accumulating shares at a price that is higher than your previous purchase.” He then correctly proclaims, “We are hardwired to avoid averaging up.” Why? Because it was a better price yesterday. But what if the price is $56 a year from today? Then buying at $51 would seem brilliant. That would be a gain of over 11%. And, if the investment was paying a dividend, the actual benefit is even greater.

I use this strategy all the time. If I buy shares of McDonald’s (MCD) and see evidence that the price will continue to move up, then I will buy more shares. But I don’t have to buy all of the shares I want on my next purchase. If I would like to add 50 shares, I might buy 10 shares per week for the next five weeks.

Adding Shares of ETF VYM

Looking at the price chart for ETF VYM will help you understand the potential opportunities over time. The 52-week price range for VYM has been from a low of $60.07 to as high as $94.86. As I type this, the price is $80.99. Those who bought at $60 are delighted. Those who bought at $94 and didn’t sell, are long-term investors who don’t conclude their investment was wrong-headed. The reality is that neither group knows what the price will be tomorrow or five years from now. Therefore, it pays to have some cash available to buy more VYM if the price drops to $75 per share. But I don’t have to wait for that. I can enter a buy limit order to buy ten shares at $80.50. Given how the market is up-and-down due to various fears and exuberance, I don’t have to dive in. I can wade in.

Suppose I bought ten shares at $73.50 (I realize knowing to buy on this date is a guess). Then suppose I bought another ten shares at $87 per share. Then my average cost per share is $80.25.

Finally, assume I bought another ten shares at $82 per share. My total cost for the 30 shares is $2,425. If I divide the total cost by 30 shares, my average cost per share is $80.83. The point isn’t that you need to find the low price to do the buy. The idea is that you don’t have to commit all of your cash on the first purchase. A prudent investor might buy VYM at $80 per share and then see if there is a pullback. If there is, buy another ten. If it pulls back more, buy another ten.

Dividend Reinvestment is Dollar Cost Averaging too

Dividend reinvestment is a method that can create wonders for investors over the long term. This method is also known by the acronym “DRIP.” It sounds like water. If you leave a leaking water faucet on with a bucket underneath, over time the bucket will fill up. Slowly, the water replaces the air in the bucket. The power of this approach is that each purchase using your dividends, buys you more shares (or partial shares) that results in more dividends the next quarter. If the company increases dividends, the growth can be healthy and amazing.

Automatic Reinvestment or Decision-based?

You can set this up to be automatic, and at one time I did this with positions I wanted to grow. This was most beneficial when there were trading commissions for buying more shares. Now that commissions are no longer a factor, I prefer to take the dividends and then decide when I want to reinvest them or perhaps buy something new. At some point I will want to spend the dividends, so this prepares my portfolio for the government’s requirement to take RMD’s (Required Minimum Distributions) from my traditional IRA.