While I wouldn’t wish a stock market crash on anyone, savvy investors know a good opportunity when they see one. The trick to making the most of such an opportunity is being prepared.
As the saying goes: failing to prepare is preparing to fail.
Nobody knows for sure when the next crash will come so it’s critical to keep some savings aside. With enough cash on hand, a cunning investor can grab the right stocks at the right time!
However, it’s important to understand the psychology of market downturns and have a strategy for taking advantage of lower prices. Turning £20k into half a million pounds is no easy feat – and involves some risk!
Here’s a breakdown of how I’d try to do it.
Maximise my ISA potential
Twenty grand is a fair bit of money so I’d need to spend some time saving to start with. It’s also the ideal amount to fill a Stocks and Shares ISA with the full yearly allowance. Using an ISA would help reduce any capital gains tax I pay on my returns.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
Smart investors know that a market crash isn’t a reflection of individual companies’ long-term value. Many solid businesses experience temporary price drops simply because of market-wide panic. During a crash, well-established and financially sound companies often become available at a discount.
So it’s important to identify which stocks have high intrinsic value but have been pulled down by the broader market.
Identifying quality stocks
Consider a stock like British American Tobacco. It’s provided annualised returns of 6% over the past 30 years. Certainly, there’s been some ups and downs in that time but overall, it’s proven a steady gainer.
Currently, the dividend yield‘s over 8% but on average it’s stood around 5% for the past few decades.
Assuming those averages held, £20k invested would grow to almost £470,000 in 30 years, with dividends reinvested. Buying at the bottom of a crash would likely deliver even greater returns.
Don’t like tobacco? Let’s consider Legal & General (LSE: LGEN), the well-established £13bn UK insurance provider. Its annual dividend has increased at a rate of 13.3% a year since 2008, rising from 4p per share to 20p.
However, it holds substantial liabilities tied to long-term policies, making it vulnerable to adverse market conditions that can affect its ability to generate returns on reserves.
That may be one reason the price is down 11% this year.
Looking long-term however, its 30-year annualised returns are also around 6%. The yield’s currently at 9.3% but on average it’s been around 6.5% since 2014. With those averages, £20k could grow to half a million in just 27 years.
Looking back to the 2008 financial crisis, the stock fell 75% that year. That would be like today’s 220p price falling to 55p. But in the 10 years following the crash, the price recovered at an annualised rate of almost 22% a year.
If that happened again, a £20k investment could balloon to over £500,000 in less than 13 years!
I wouldn’t put everything in one stock though. Rather, I’d aim for similar average returns by diversifying my investment across a portfolio of stocks. This helps to reduce exposure to industry- or company-specific risks.
This post was originally published on Motley Fool
