The rush to the safety of cash and bonds is in full flight. But over the long-term, the strategy is doomed to failure. Instead, focus on buying cheap shares for less than they are worth. We name 6 cheap companies.
There's bleak news as far as the eye can see. The credit market is still locked up. Big banks are failing left and right. Home prices have been dropping at a record pace. And all of this turmoil is hurting the economy, with most retailers reporting dour results.
In the face of all of this bad news, it's tempting to sell and wait for better times. When your portfolio falls by 15% in a month, a gilt yield of a 2.5% starts to look pretty good.
But that can be a huge mistake.
The safest way to lose money
While gilts may ensure that you don't lose money in the short term, they can also ensure that in the long run, you don't have enough money for retirement. In fact, it's possible that in real terms, you'll actually lose money in gilts.
Recently, 5-year gilts have been paying about 2.5%. From this, you have to subtract taxes, which lower your return. But that's not all. The latest UK inflation rate was 3.0%, eroding the value of both your principal and interest. While inflation is expected to moderate significantly over the next few years, when you add it all up, it's clear that if you take into account inflation and taxes, gilt investments could lose you purchasing power.
Maybe you'll claim that gilts are just a short-term hedge, and that you'll buy back into the stock market when the volatility is over. But by the time you see nothing but blue skies, there's a good chance that the market will have rallied, and you will have missed out on a large chunk of the profits.
Lower-risk investing
However, there is a strategy to both reduce risk and achieve huge profits in the stock market. And the strategy actually works best in a choppy market like the one we have now.
Just buy shares for much less than they're worth.
The reasoning is simple. If you pay 100p for a company that's worth 180p, it's much more likely that the shares will jump to 180p than fall to 50p. So you've reduced your downside risk. At the same time, you still have a huge upside because you can be confident that the shares will eventually return to their fair value. Buying undervalued companies helps to ensure that you buy low and sell high.
Some cheap shares
Right now is the ideal time to look for bargains. Just look at how cheap some of these shares are:
These are all big names that aren't directly tied to the current housing and debt woes. They all have significant competitive advantages in their niche. Sure, these businesses will feel the effects of a recession, but it's likely that they will survive any short-term turbulence. Yet they're all trading at significantly lower valuations than they have for the past five years.
These shares can be bought more cheaply now than they could have been in the past (though the P/E is a rough measure of value). But if you wait for everyone to be happy with the economy, it's likely that you'll miss out on much of the upside. That's why, in a market like this, you should be particularly active in identifying undervalued opportunities.
Some even cheaper shares
What's more, these shares -- although cheap -- aren't necessarily even the best opportunities in the market.
Our Motley Fool Champion Shares premium stock picking service focuses on finding smaller, cash-rich, dividend paying and downright cheap shares that have the best potential for extraordinary returns. Chief Analyst Maynard Paton has identified several hugely undervalued shares, including one from the list above, that he believes will outperform in this choppy market. If you're interested in checking out all his current recommendations, we offer a free trial.
More on the economy, investing and the markets:
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> This article was first published on Fool.com. It has been updated.
> Bruce Jackson does not have an interest in any of the companies mentioned in this article.
