Anytime the stock market goes down, people start talking about “dry powder.” Dry powder is a reference to a habit among frontiersmen, soldiers, and sailors to keep some of your gunpowder in a dry location, because wet gunpowder doesn't work. So dry powder is what you pull out when you're attacked right after a downpour.
Dry Powder in Finance and Investing
When applied to financial markets, keeping dry powder is simply a market timing strategy, where the market timer feels the benefit of having cash to invest in a downturn outweighs the “cash drag” of keeping that powder dry the rest of the time. You'll also hear real estate investors talk about having cash available to invest in case a really good deal comes up and must be acted upon quickly. That's basically the same thing. Another common phrase heard in a downturn, “Cash is king” has a similar meaning.
To be fair, sometimes people use the phrase “dry powder” as a behavioral crutch, to help them to stick with their investing plan behaviorally. In that respect, it is no different from a buy and holder celebrating the opportunity to tax loss harvest, rebalance, or buy low with their next 401(k) contribution. If it helps you to stay the course, it's a good thing. Sometimes people simply use the phrase inappropriately, for example: “I just got paid so now I have some dry powder to put into the market.” That's not really dry powder that you kept in the event of misfortune. Kind of like the difference between dollar cost averaging and periodic investing. If there was never a lump sum you could have invested all at once, you can't actually dollar cost average, you're just periodically investing.
However, there are some people who seriously think that keeping dry powder is a good strategy — that you will actually come out ahead for doing so. Personally, I have always thought cash drag would outweigh the opportunity to buy low, especially when you take into consideration transaction costs, taxes, the value of your time, and the likely behavioral errors inherent in doing this sort of a thing willy-nilly, but I confess I have never run the numbers personally. Today, I would like to do that.
My “Dry Powder” Hypothesis
My hypothesis is that a dry powder strategy is a bad idea, that you'll be better off staying fully invested. In order to test this hypothesis, we'll have to take a look at some retrospective data. This comes with lots of limitations. Let's list them in advance so we are all aware:
- Past performance does not indicate future performance
- The performance of one asset class does not indicate the performance of every asset class
- A strategy may work in one time period but not another
- Just because one strategy didn't work doesn't mean no strategy could have worked
So what asset class and time period will we look at? Well, let's pick a convenience sample, since access to ideal data is often limited. Let's use the US stock market as tracked by the Vanguard ETF VTI, the Total Stock Market Index ETF. Our time period will be the longest time period that I can obtain quarterly returns for the fund. In this case, our period begins with the first quarter of 2010 and runs through the present, May 28, 2020, the day I did this analysis.
I have tried to pick a simple, straightforward strategy that could be followed robotically without having to watch the market every single day. Here is the strategy and assumptions I followed:
- In any quarter where there is a loss of 10%+ over the entire quarter, we will put “dry powder” into the market at the end of the quarter.
- We will leave the “powder” in the market until the end of the quarter in which the % gain is equal to the loss in the losing quarter.
- When the “powder” is not in the market, we will place it in the Vanguard Prime MMF.
- To keep things simple, we will not add any new money to the portfolio over the time period.
- We will assume this all takes place with zero transaction costs (no bid-ask spreads, no commissions) and in a tax-protected account, so there are no taxes on dividends or capital gains. Obviously, this skews the data a bit in favor of the dry powder strategy, but I want to give it every possible chance to succeed.
The Placebos
Before we run the analysis, let's take a look at three placebo arms in this “trial”:
Placebo # 1 Staying Fully Invested
If you take $100,000 and invest it into VTI on from January 2010 through May 28, 2020, you would end up with $331,206.
Placebo # 2 Leaving the Money in Cash
If you take $100,000 and invest it into the Vanguard Prime MMF from January 2010 through May 28, 2020, you would end up with $106,502.
Placebo # 3 Placing 75% of the Money into VTI, and 25% into Cash
If you take $100,000, and place $75,000 into VTI and $25,000 into Prime MMF, and leave it there from January 2010 through May 28, 2020, and rebalance it at the end of each calendar year, you would end up with $255,432.
The Analysis on Dry Powder Investing
If you take $100,000 and put $75,000 of it into VTI and $25,000 into Prime MMF (the dry powder) starting in January 2010, and then move the dry powder into VTI after every quarter with a 10%+ drop in the market, and leave it there until the % of market recovery in a quarter is at least as high as the loss (12% loss must be followed by a 12%+ gain), you will end up with $304,299.
You would have put the dry powder to work in four instances:
- 3rd Quarter of 2010
- 4th Quarter of 2011
- 1st and 2nd Quarter of 2019
- 2nd Quarter of 2020
Here's the data if you feel like spending a couple of hours crunching numbers to check my work.
The Bottom Line on Dry Powder
Let's recap.
- Fully Invested: $100K –> $331K
- Not Invested: $100K –> $107K
- 75% Invested: $100K –> $255K
- Dry Powder Strategy: $100K –> $304K
Obviously, this is only one strategy, one asset class, and one time period. If you change those three factors around enough, you will likely find a time when a dry powder strategy came out ahead. If you torture the data long enough, you can get it to confess to anything you want. But in a simple, reasonable look back at this strategy, it did not perform. Cash drag matters more than having dry powder to invest. Yes, it does a little better than keeping dry powder all the time, but not as well as just staying fully invested. This is not intuitive to many people. Check out this Twitter poll I did back in April:
A dry powder strategy is market timing. And market timing usually doesn't work. Even an unemotional, robotic strategy is unlikely to bring enough advantage to overcome the opportunity cost/cash drag, and that's without taking taxes and transaction costs into account. The typical, emotion-based strategy most of these folks use is almost certain not to work well. It's just an excuse to try to time the market.
Update after publication (10/20/20):
I received a bit of feedback on the study that it was not useful due to three issues with the “study”:
- There was no money added during the study period
- The dry powder was not left in the account
- The study period wasn't long enough or didn't include enough bear markets or in some way was cherry picked
To address issues 1 and 2, I did another study, using the same returns, but starting with $1M in the account and adding $100K a year. In the fully invested account, the $100K went into stocks. In the dry powder account, the $100K went $80K into stocks and $20K into the dry powder fund. The dry powder account started with $800K in stocks and $200K in cash. The entire cash account was dumped into stocks at the end of any quarter with a 10%+ drop and left there to the end of the study.
The results were the same as the study above. I also included data from Q2 and Q3 of 2020.
Final totals:
Fully Invested Strategy: $5,725,029
Dry Powder Strategy: $5,718,327
The benefits of dumping dry powder in at market lows did not overcome the downside of cash drag. I also ran it with the entire $100K added each year going into the dry powder (cash) fund. It performed even worse than the above. I suppose the only good news is that the dry powder strategy was not significantly worse, so if you want to try it in a tax protected account, it may not cost you much and maybe over some short time period, could even come out ahead.
What do you think? Do you use a dry powder strategy? Why or why not? Were you surprised by these results? Comment below!
The ability to throw a sizable chunk of powder at the problem during a downturn can definitely provide a psychological boost. But how much are you willing to pay for that fleeting feeling? You’re right, it’s probably A LOT more than you think you are paying…
I think two psychological/financial errors I see people make are:
1) Confusing their Emergency fund for dry powder, and
2) Using a cash or money market position in their financial plan as dry powder, but not admitting that they have changed their plan by doing so
I too have equated those talking about having dry powder as another form of market timing.
Even so I admit that sometimes I engage in that activity when I see an asset class I like take a big hit (I usually use my cash reserves to put in play that I had been saving to hit the minimum in a syndication deal or I sometimes poach from my emergency fund which I then rebuild).
I think March provided some interesting opportunities and I put some money into reits and even the Vanguard energy fund (which hit historic lows). Only time will tell if I am going to look smart or not
Is that in your written plan? “Buy Vanguard energy fund when it hits historic lows.” I’m skeptical.
It still actually fit in the plan where I have up to 5% of net worth to use as “swing for the fences” discretionary investing. I have a little bit of money in several speculative areas just to see “what if” happens if they take off. Had it in Tesla but sold way too early when it started taking off. So deployed some of that into other things I thought might have a fighters chance.
The funny thing about index fund investing is not only did I buy Tesla stock before you did, but I didn’t sell it too early either. 🙂
Great post! Totally agree! I additionally hear the comment that when the market drops one should use (some of) their emergency fund as some “dry powder” to invest. This makes no sense to me either as this is the exact time you would want your emergency fund available to avoid selling shares when the market is down if there is an emergency….which is the whole point. Thanks for all you do!
Exactly. I agree an emergency fund is definitely not dry powder.
Nick Maggiulli did a great analysis comparing dollar-cost averaging and lump-sum investing: https://ofdollarsanddata.com/dollar-cost-averaging-vs-lump-sum/
Even a disciplined dollar-cost averaging likely doesn’t beat lump-sum investing, so dry-powder strategy surely wouldn’t. I’ve learned my lesson this past year, and hopefully, it’ll be the last time I keep a dry powder. I’m planning on maxing out my wife’s and my Roth IRAs on the first biz day of 2021.
Why not invest the money sooner and use money earned in 2021 to max out that Roth IRA?
We’ve already max’ed out our Roths and invested the cash. Only cash we now have is $12k to max out the Roth’s and the rest is for my wife’s federal student loan once the forbearance ends. Sorry if I wasn’t clear.
I assume you meant “money earned in 2020”? I guess we could invest it in taxable, but is it worth the risk? For context, I’m an MD/PhD student while my wife works.
What risk? The risk of the market going down? You think that goes away in January?
You mean you don’t think you’ll be able to make a Roth IRA contribution if you don’t keep the money in cash? For 15 months afterward? Doesn’t seem worth holding cash for 3 more months to avoid that issue. In fact, that’s a great issue to have. You could tax loss harvest and buy even more stocks in the Roth than you would have been able to before by adding more money to it from current/future earnings.
Thank you for helping me look at it differently.
My initial reasoning was that if I invest in Roth in January, I don’t have to worry about the short-term risk afterwards while doing so now would mean I’ll worry about my investments.
Now I see how with TLH, investing it now is better esp if I extend the timeline to 15mo (or even until Apr 22).
When I saw the title of the post, I immediately thought “this sounds like market timing, and there’s no way WCI would endorse that…” and then I read the post and saw your math, etc…. and all I can say is what a fantastic post. Thank you for all you do for the community. I really enjoyed your talk at PIMD’s recent conference.
Also, you are probably familiar with this, but for your readers of comments, Vanguard did a “study” retrospectively to evaluate whether “dollar cost averaging” makes sense, and their conclusion was that it is just form of market timing. Google “vanguard dollar cost averaging pdf” to find it. Cheers and happy investing!
Not surprised. That has been my position for years.
https://www.whitecoatinvestor.com/dollar-cost-averaging-is-for-wimps/
This notion implies the dry powder is only for market timing and not for opportunities. I always kept a fund I called my opportunity fund. This allowed me to participate in something that crossed my path that required cash money. It was not for market timing. Some examples I used it for over the years: Purchasing land in a partnership to create a surgery center, putting in the seed money to build the surgery center, investing in a friend’s start up business, seed money to start an independent physicians association, buying half a house from my friend to save him from bankruptcy by retiring his mortgage, donating to an emergency relief operation after a tsunami, buying a car for a missionary we support who was in need, replacing the engine in a pastors car, making a big donation to a hospital drive to build a facility to house out of town family members of patients…… All of these opportunities crossed my desk and required cash. If I had been required to sell off some stock to do them, I might have passed. Many others missed out because they did not have any cash. I have always used the money for things that came up and never once used the money to time the market on an investment. Cash is king and many good things do not happen for lack of cash. I think I will continue to keep some cash on hand as dry powder. (Different from my emergency fund) I’m not concerned if that money was not optimally invested for maximal return since I have enough return elsewhere. I’m concerned with not being liquid enough to do some great things.
Dr. Cory S. Fawcett
Financial Success MD
How large would you suggest an opportunity fund be?
It would be interesting to run your own numbers (similar to what WCI did above) and compare your options (ie. compare investing your opportunity fund account vs. keep cash available for spontaneous opportunities like you describe). That way, you would at least know what the cost is to keep an opportunity fund… even if it is not financially beneficial.
Tim, the size depends on how big an opportunity you would like to be able to do. I kept that account at $50,000. If I used it, then I would replenish it.
I would not bother doing the calculation as to the cost as I don’t care what the answer would be. It is not about investing for return. I learned long ago in medicine to not order tests that will not change your therapy.
Dr. Cory S. Fawcett
Financial Success MD
Why not just use a HELOC or portfolio loan for those time sensitive opportunities, which you then payoff from income?
It isn’t written down in my IPS, but one of my longstanding beliefs is there is an opportunity to earn above market returns on time-sensitive investments, such as foreclosure sales, gov auctions, possibly certain private investments. Rather than keep cash, I used a HELOC to buy a 20K tax deed, for example.
Alex,
Many of the opportunities I took advantage of I would have never been willing to borrow against my home to do. I would not take a loan out on my own house to save a friend from loosing his house, risking my house to save his could mean losing them both. I would not borrow money to send for tsunami relief as that should come from money I actually have. A HELOC on my home puts my home at risk , which I am not willing to do for hardly any opportunity. If you have read my book, The Doctors Guide to Eliminating Debt, you will know that I am a bit debt averse. I haven’t had a loan against my house for the last 19 years and intend to keep it that way. I don’t see the equity in my home as a piggy bank to be used for a bet on a “sure thing.” My feelings are these are the types of opportunities that should be taken with real money, not money I had to borrow from someone else.
Dr. Cory S. Fawcett
Financial Success MD
I agree Cory.
I’m terrible at timing the stock market (isn’t everyone?).
But having a large stash of cash at the ready has been helpful to me. Sometimes opportunities present and pass quickly.
I have been able to buy into surgery centers, rental units, private companies, senior living facilities etc with a narrow timeline. Not everyone can or should do that. Some would spend it or speculate impulsively. Maybe that is an “opportunity fund” instead of “dry powder.” I’m not sure. I just know it pays to be ready.
I have yet to have a big opportunity that needed money in less than 48 hours. I can come up with A LOT of cash in 48 hours, without any “dry powder.” It wouldn’t even cost me much in taxes because I’m continually flushing capital gains out of my taxable account by donating appreciated shares. Now if all your money is in retirement accounts and/or illiquid real estate, I think you could make more of a case for an opportunity fund.
So long as you have some liquid investments, you should be able to liquidate for big things like that. Yes, it’ll cost you some taxes but you’ll come out ahead of holding cash “just in case.” But if your portfolio was 100% apartment buildings, then I could see holding some cash.
I like the idea of the experiment, but the biggest flaw I see is pulling out at some arbitrary point. I.e. when the dip equals the gain. When one mobilizes their cash in an opportunity it should still be for the long haul. The experiment should let the money ride. New dry powder must then be accumulated.
Personally, I would sacrifice a savings goal to take advantage of a large correction. As an example, keep my car or house longer and prolonging gratification to move a large sum in the market during a 30% dip. Then restarting the saving process for some luxury item of consumption.
That’s the biggest flaw you could come up with? I can come up with 3 or 4 bigger than that.
At any rate, you’ll notice I did the “experiment” in way to make the calculations relatively easy. If you would like to do your own and test your hypothesis, be my guest. You’re the 4th or 5th to suggest it this morning, but I haven’t found a taker yet.
Ain’t nobody got time fo dat. Except someone who profits from the content.
On a serious note, that’s just where I feel like it lost real life practicality.
I imagine a disciplined investor who likes to buy the dips also holds the investment for the long haul.
One can always imagine ways to make a study better (and I agree your suggestion would make it more practical). But you go to battle with the army you have. And you do studies with the data you can access and the ability you have to work with it.
Wait, but does this imply that you only leave the invested money in VTI until it recovers? What about if you leave it there permanently, replacing the money in your “dry powder” account later on from earned income? I confess to using money from my emergency fund for the first time ever in March when the market tanked, but that’s because I have a secure job (tenured professor) and I’ve always viewed my emergency fund not as a set number but more as a range of comfort (i.e. 6mos to 3mos of income – I’m happy with either but feel a little more secure with 6mos). I’d never thought of investing that emergency money before, but couldn’t resist the opportunity to buy more stocks when they tanked more than 30%, which I guess is my number for deploying some of the emergency money (not 10%).
Feel free to run the numbers and let me know what they show under that scenario.
Great treatment of what I think is really mostly a common myth. In retirement I have a ridiculously large amount of cash but I consider it to basically be as good as my bonds right now. But I also have more than enough stocks and some alternatives to more than support my retired lifestyle if I ever stop earning more than I spend from my hobby consulting. I did tell myself the cash was dry powder at first, but the simple truth is I enjoy having a pile of cash. I enjoy it more than I enjoy being fully invested when the market tanks and when the market grows I still have plenty in equities growing with it. I still have my target 55% stock portion but my 40% bonds allocation is partly bonds and partly money market. My emergency fund is CD’s, “high” interest savings accounts and checking accounts. And maybe 5% is alternatives.
Cash as part of your asset allocation is not “dry powder.”
I agree, it never was, I just told myself it was. I was never planning on putting in equities.
Thanks for this post! You’ve articulated a lot of thoughts I’ve had for quite some time. I have seen this “dry powder” strategy articulated in so many places, from disciples of Bogle & WCI commenting and posting on these kinds of sites, to family members insisting they can tell when there will be a “historic low.” You would think they haven’t even read the basic stuff (or forgot it)!
Maybe being extremely “hands on” with finances gives some people overinflated confidence. Who knows… I’m fine with being boring and sticking to an IPS with regular contributions, regardless of whether the index ticker is green or red.
1) Your example was completely artificial as your did not keep the “dry powder” invested for a prolonged period of time, thus negating the ability of the invested dollars to grow over the long-term.
2) Per Mr. Buffett : “Be fearful when others are greedy, and greedy when others are fearful”. While we shouldn’t manage our portfolios as billionaires do – they became billionaires for reasons which include ‘smart ideas”. It seems quite wise to try and emulate some of the ideas billionaires used to accumulate their wealth. ie best to emulate winners, not losers.
3) Nick Maggiulli, or one of his colleagues at Ritholtz, posted a column soon after the market decline in March. His/their analysis found that the best or strongest gains occurred from funds invested during market dips, over the LONG term. I say this somewhat “tongue in cheek” that market timing gets a bad rap. It seems to me that people have associated it with buying at exactly the market bottom, and then selling exactly at the market peak. No need to be so greedy. One can generate significant profit by merely buying funds on sale, though it may still become cheaper still, and then selling when it rises, even if not at the top. Why wouldn’t you want to buy things when they’re on sale. You wouldn’t pass up a significant sale at the grocery store or electronic store, etc. , or would you say, “I don’t market time, so I will wait until prices return to normal 😉
4) this concept of: “Was it in your investment plan” sounds quite childish and inflexible. Life happens and doesn’t always follow a plan. If you came across an opportunity that you felt was an excellent investment, but wasn’t in your investment plan, what would you do ?
When the market had a tantrum in Xmas 2018, after a Fed speech, and dropped 20% for seemingly no reason, I took advantage and shifted some bonds to stock. I think it was a good move…
1. Bla bla bla. You and half a dozen other people think this is a fatal flaw, but not one of you has bothered to run the numbers without that simplifying assumption. If you just put the dry powder in once and left it, it wouldn’t be much of a dry powder study would it? The next dry powder must come from somewhere, and in this simplified scenario with no new money added, it must come from selling equities.
2. You can try to do what Buffett does (as many have done but few have succeeded at), or you can take his advice. I’ve chosen the second.
3. I agree that the lower the price you buy an investment at, the better your return on it will be. Of course I would prefer to buy things on sale, but the problem is you never know when you are at an all time low moving forward for sure. But looking back, you can see that the market is at an all time low (moving forward) quite frequently.
4. I would follow my plan. It has worked very well and allowed me to meet all of my financial goals, come up with new ones, meet those, come up with new ones, meet those etc. I would expect it to continue to do so. It also helps me avoid the much more significant behavioral pitfalls that many people fall into investing in the next shiny opportunity that comes by.
I also bought lots of stock in December 2018…and March 2020…and every month in between. Amazing how that “dry powder” stuff shows up in my bank account every month to be invested.
If that sounds childish to you, so be it. Sophisticated does not have to be complicated.
I (unfortunately) find myself sitting on cash with each retirement contribution for the following reasons:
1. Rebalanced during the Spring downturn (selling bond funds/buying stock funds) to keep desired asset allocations.
2. Large resurgence in equities have meant most contributions in recent months have gone to the bond side of assets (to recorrect towards that desired allocation without selling equities to “rebalance”).
3. Majority of retirement contributions go into my brokerage account (which doesn’t have a bond position).
Therefore, I can exchange equities to bonds in the tax-deferred accounts, to make room to buy equities in the brokerage account (I’ve done this a few times). Or, just sit on the cash (MMF) in the brokerage account until it’s time I’m supposed to buy stocks per my investing plan. I categorize this MMF cash in my brokerage account as part of the “bond” asset allocation, and since bond returns are so low, I don’t lose too much sleep over this cash sitting around for a while.
Would this be considered “dry powder”? Who know’s, it’s what I’m supposed to do per my investment plan, and if it sits in cash rather than bonds for a month or three, oh well.
Definitely agree! I suppose calling my bond allocation potential “dry powder” is like calling periodic investments DCA.
Even so, with a stock downturn big enough to trigger my rebalance metrics (such as spring 2020), my fixed income allocation works pretty well as a source of $$$.
I think people just call that rebalancing.
Re my comments above: the link to the Nick Magguili article is :
https://ofdollarsanddata.com/buying-during-a-crisis/
Note the following paragraph from the article :
This plot demonstrates that buying nearer the bottom usually provides 50-100% in additional growth compared to investing during other periods. This means that your same $100 would grow to $150 or $200 (adjusted for inflation) by the time the market recovered.
I agree. You should always buy low and sell high. Good luck identifying that a priori.
You don’t need to identify it a priori. Market fell Xmas 2018. Buy stock. It recovered (and then some !). Market fell in March 2020. Buy stock. It recovered. as well. Unless you believe the market will NEVER recover from a drop , you really don’t need a crystal ball.
I can’t tell if you’re serious or just trolling me.
First, I did buy stock each of those months, with my regular monthly contributions.
Second, what I did not do is put some cash that I had been holding out on the side for months or years into the market in those months, because I didn’t have it. Because I invested it already.
If you are doing that, then yes, you will need a crystal ball to know if you are better off holding cash waiting for the next drop or just investing it when you make it. The study above showed provides evidence for the likelihood that it is statistically better to just invest when you get the money since the market usually goes up. Behaviorally speaking, this is also best since it can be made more automatic.
Good luck investing.
The question I have is if instead of using “dry powder,” you use money from you bond allocation (so not dry) then replenish those bond via your investment plan with new money. Granted I haven’t run the numbers and frankly am not the math whiz to do it correctly, but I can’t imagine how transferring already invested money from one source to a higher return source at a lower market then leaving it there wouldn’t have you ahead. I may not get the market low right, but I lost less money on that bond during the drop before I sold it (most likely) and bought a total market stock at a lower point. Doesn’t really require timing the market because you aren’t trying to predict the market going lower. It already is lower.
I read below and you basically responded to a similar question. Cheers.
Yea, the reason it doesn’t work as well as you would think, if at all, is you lose the returns while waiting for the downturn.
Just curious why you lose returns (or no improved gains)? Unless we are referring to different things. I’m saying I keep an allocation of bonds of 10% currently. When the stock market drops 10%, I just move some of those bonds to stocks and decrease my total % of bonds…then reinvest new money back into bonds as the market increases. Are you stating that this also doesn’t really increase returns too. Many thanks.
Depends on the time period, but I would not expect it to do so over the long run. Besides, if you could do it successfully why would you limit it to just a small % of your portfolio. It either works (and you should do it with a lot of money) or it doesn’t (and you shouldn’t do it with any money.)
While I agree with your general assessment of dry powder == market timing, I’d also consider the current use of funds in the account. If you are in wealth accumulation mode and saving for a future goal, then by all means dollar cost average on a regular schedule or lump sum in for a long, no withdrawals investment horizon.
If you are currently taking regular distributions and consistency of income over a finite period is important to you, then you may want to keep a little “dry powder” or cash reserve to protect your future distribution stream from sequence of return risk.
One simple rule of thumb is to keep just enough sweep cash to cover one year’s worth of the required equity value in a stock-to-bond portfolio, or in this example, the VTI portion of a VTI/BND portfolio. Then in a down stock market year, you have the option NOT to partially liquidate VTI and instead use the cash reserve cover the equity portion to meet that year’s distribution requirement, giving VTI at least a year to recover before the following year’s distribution.
The opportunity cost of holding cash in this scenario needs to account for not only the loss of return potential by holding cash but more importantly the potential loss of lifestyle if one’s income stream is significantly impaired.
I agree retirees should hold 1-5 years of cash withdrawals. But I wouldn’t call it dry powder. Dry powder is money waiting to be invested, not withdrawn.
1) Why would you invest black powder after a 10% crash when true market crashes take out nearly 50% of the value of any given asset (2009-2010)?
2) Why would you sell the asset once it appreciates 10% in value? Anyone who invested after the crash of 2010 and pulled everything out after a 10% gain would be very regretful observing how the market has performed since then.
3) Isn’t it funny that the data only looks at 2010 till today? It’s been quite the bull market.
1) If I had done a study using 2010-2020 data where I don’t invest dry powder until there is a 50% drop in the US stock market the dry powder strategy would not have outperformed because it would have been in cash the whole time.
2) It’s a study of dry powder. Without new investments (my simplifying assumption) there is nowhere else to get dry powder again than from selling stocks. You’re welcome to change the assumptions and do your own study and post it here.
3) Not particularly funny, just convenient because Vanguard leaves 10 years of data accessible on its website. If you have additional data, you could use a different ten years or better yet, a longer time period.
It’s easy to criticize a study for what it didn’t do, but we’re all sitting here waiting for you to do the proper study of this question and publish it.
Everyone knows that in order to effectively time the market you have to be right twice. What I like to point out is that the “dry powder theory” is already an admission that you were wrong once. By not having money in the market during the run up, you have effectively failed to sell high in the first place!
Adding an update based on feedback via email, these comments, and comments on Bogleheads.org.
Update after publication (10/20/20):
I received a bit of feedback on the study that it was not useful due to three issues with the “study”:
There was no money added during the study period
The dry powder was not left in the account
The study period wasn’t long enough or didn’t include enough bear markets or in some way was cherry picked
To address issues 1 and 2, I did another study, using the same returns, but starting with $1M in the account and adding $100K a year. In the fully invested account, the $100K went into stocks. In the dry powder account, the $100K went $80K into stocks and $20K into the dry powder fund. The dry powder account started with $800K in stocks and $200K in cash. The entire cash account was dumped into stocks at the end of any quarter with a 10%+ drop and left there to the end of the study.
The results were the same as the study above. I also included data from Q2 and Q3 of 2020.
Final totals:
Fully Invested Strategy: $5,725,029
Dry Powder Strategy: $5,718,327
The benefits of dumping dry powder in at market lows did not overcome the downside of cash drag. I also ran it with the entire $100K added each year going into the dry powder (cash) fund. It performed even worse than the above. I suppose the only good news is that the dry powder strategy was not significantly worse, so if you want to try it in a tax protected account, it may not cost you much and maybe over some short time period, could even come out ahead.
So after ten years there is a difference in the two accounts of $6,702. In comparison to the account balance, $5,725,029, that is a difference of 0.00117. Seems like that falls into an amount that “doesn’t move the needle.”
So the question is what to do about it. One response would be “well I can try, it probably won’t hurt me much.” The other response, which I think is better, “Is it didn’t make a difference, why bother?”
Keep in mind as you look at that tiny difference that most of the time there was only $20-40K of MILLIONS that was in the dry powder fund. So you’re making a tiny change and shouldn’t expect a big outcome in the end. If you put more in the dry powder fund, the underperformance is worse.
The overall point, of course, is that dry powder didn’t come out ahead so you shouldn’t do it if that is your goal.
I haven’t always been good about it, but here is my “strategy”. I imagine investing into index funds as the knob on my car’s thermostat. I can turn it all the way to heat(into the market) or all the way to cold(cash/money market) or anywhere in between. Every month I try to save $1,500, which will get allocated based on where my knob is turned. My “knob” is normally on 95% heat, but if I feel the Shiller P/E is getting high, I’ll turn towards cold. This way I have a dry powder account of cash ready to be invested. If I had been doing this religiously for years I would have data on whether or not it works, but I don’t. Either way, it’s funner this way 🙂
I guess the question is how much is that fun costing you and is that worth it to you? 🙂 Investing by emotional feel or by the Shiller P/E has not been shown to be profitable in the past.
What about using your bond allocation as dry powder, i.e. “buying on the dips”–using some market metric (Shiller P/E) or your rebalancing band to trigger a new asset allocation that is heavier in stocks, in order to try to take advantage of a dip in stocks? Granted, this is market timing. To re-build your bonds, you could direct new money to bonds.
If your written investing plan says you should “overrebalance” and defines exactly how to do that, then go for it. But I wouldn’t do it based on feel. Make sure the plan also dictates when you go back to your previous AA.