Whenever I read remarks like this, I'm tempted to cite the gambler's axiom "the dice have no memory." Or to put it another way, the law of averages works by swamping, not by compensation.

Suppose you flip a fair coin ten times and it comes up heads ten times in a row. At this point you've flipped heads 100% of the time.

Now suppose you flip it some more. The odds of its coming up heads are 50%, same as before, no greater, no less. The most likely outcome if you flip it a thousand more times is that the next thousand tosses will be 500 heads, 500 tails. If you add the initial run of ten heads, you get 510 heads, 500 tails = 51% heads.

That's the law of averages at work. The first ten heads weren't counteracted or balanced, they were just swamped out by a long run of further flips that ran about true to average.

Apply this to an efficient market in which the market price is a random walk around some underlying trend. Let's say you believe the underlying trend is for a 7.1% return going forward, i.e. doubling in ten years.

If your stock index fund is worth $14,000 now, then in ten years you expect it to be worth $28,000.

Now let's say the market suddenly drops and your stock index fund is worth $13,000. Your expectation should still be a 7.1% return going forward from the present time, so at this point your expectation should now be that it's going to be worth $26,000 ten year from now... and that any more stock you buy "on the dip" should behave the same way, not better.

If the expected happens, people who bought the index fund at $13,000 will see $26,000 = a 7.1% annual return in ten years. The people who bought it at $14,000 who see a terrible "loss" of 7.1% in a couple of

*days*when it dropped to 13,000. If they don't panic and patiently hold out for ten years, they will see their $14,000 become $26,000, 6.38% annual rate of return. They indeed recover from their loss and make something approximating the expected 7.1%. But that's not because the stock market compensated for the drop, it's just because the longer-term behavior swamped out or diluteds the short-term variations.

Believing that "buying the dips" is advantageous assumes that you're buying

*the same thing*after the dip as you did before. But you're not. In most cases, you're buying a company that has just announced disappointing profits or something like that, so it's

*not as good*as it was before.

Suppose you were about to buy a used car from a friend for $14,000, and he called you up and said "I'm sorry, someone hit it in the parking lot and made a dent and a big scratch on the side. I have an estimate from a body shop that it would take $1000 to fix it. You can have it for $13,000 now." What would your reaction be?

Would you say "Oh boy, this car is a

*much*better deal than it was before, because the price just dropped $1000? Sweet! I like to buy cars when they're on sale!"

No, it's about as good a deal as it was before, no better, no worse.

This doesn't mean there's anything wrong with buying the dips, but I think it's a delusion to think that there's any reason to go beyond buying enough to maintain one's chosen asset allocation.