When the stock market falls, that might seem like bad news for investors.
The reality, though, is that a falling stock market can be bad or good depending on how one reacts to it. For a canny investor, a stock market correction or crash can offer the opportunity to buy into some great companies at a cheaper price than before.
For now, the stock market continues to do well. The UK’s flagship FTSE 100 index has hit an all-time high this year. It is currently around 2% below that all-time closing high.
But sooner or later, as history shows us, there will be a stock market correction. Here is how I would use that to try and turn a £30k sum into a portfolio worth a cool million pounds down the line.
Taking advantage of weak prices
Imagine that I invest in a share portfolio that, on average, grows in price at 5% annually and has a 7% dividend yield. That is equivalent to a 12% compound annual gain.
Now imagine that a stock market correction sees that selection of shares fall by 15%. If I bought then, that 5% annual price gain would end up being a 5.75% annual price gain thanks to my lower purchase price.
Meanwhile, the average dividend yield would not be 7% but 8.05%, again thanks to my lower purchase price. So my compound annual price gain would be 13.8%.
This is where the long-term benefit of compounding really shines through. Compounding £30k at 12% annually, my portfolio would be worth over a million pounds after 31 years. At the higher 13.8% rate, though, hitting the million pound mark would take 28 years.
Getting ready now to hunt for bargains in future
Remember, this example presumes I spend the same amount buying the same shares. The only difference between the two scenarios is that in one I buy before a 15% price fall and in the other, afterwards. In a stock market correction, some individual shares may fall a lot more than that, giving me even more scope to scoop up bargains.
But just because a share falls does not mean it is cheap.
I still need to focus on quality – and in the midst of a market meltdown I might not have enough time to do the research. That is why I am updating my share watchlist now, to get ready to move when the next stock market correction comes.
One name on it is M&G (LSE: MNG).
During the 2020 stock market crash, the M&G share price fell sharply. If I buy it today, I could earn an already juicy 9.5% yield. But if I had snapped up the share at its 2020 low, I would now be earning a yield of over 18% annually!
With a customer base in the millions, strong ongoing demand for asset management, and a strong brand, I think the company is set for ongoing success. One concern is what the firm this month termed “elevated” geopolitical risk that threatens economic stability and investor confidence.
But, if the next stock market correction lets me snap up more M&G shares at a bargain price, I plan to!
This post was originally published on Motley Fool
