Buying on the Dip is a Critical Piece of the FIRE Puzzle – Investorplace.com

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.

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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 CNBCs Becky Quick that Berkshire Hathaway (NYSE:BRK.A, NYSE:BRK.B) would be buying on balance.

Buffetts built a career buying stocks on the dip because thats one of the best ways to make money over the long haul.

The Financial Independence, Retire Early (FIRE) philosophy doesnt 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 youre dreaming of retiring at 40 when youre only 25 today, its 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, lets assume that Im 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, Ill have approximately $1.09 million accumulated over those 15 years. Of course, that doesnt take into account tax-advantaged investment accounts, etc., but thats a discussion for another article.

For now, Im 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, youll be well on your way to financial independence.

Before delving into the specifics of the plan, its 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 thats good news. The bad news is that many financial experts dont 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 wont even come close to matching its annualized real total return of 11.5% between 2010 and 2019. For many, the best days dont lie ahead.

Taking the path of least resistance and investing in SPY isnt 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, youll have to step up the risk considerably.

On the one hand, the fact that youve committed to saving a big chunk of your income means youll have the time to investigate specific growth stocks, since you wont be out at the club dancing the night away.

However, in addition to accelerating your investment plan, you do have to remember that you cant buy on the dip if you dont have the cash to invest. Youve 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 peoples 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.

Its 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 ETFs $32.8 billion in total net assets. If you buy XLK, its essentially a bet on those two stocks and not much else.

Dont get me wrong; if youre looking to accelerate your investment returns, XLK is a great place to look. However, as I said above, if those two stocks dont perform over the next 15 years, the likelihood of reaching a million-dollar portfolio is slim to none.

So heres what I would do.

First, Id 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. Its 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 wouldnt 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, Ive been recommending investors avoid specific airline stocks. Instead, Ive 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 dont just buy JETS. Figure out how much you want to bet on airlines, use 50% of the cash youre 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. Theyre in the know when it comes to technology.

FIRE away!

Will Ashworth has written about investments full-time since 2008. Publications where hes 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.