While inflation continues to move in the right direction, fears of another stock market crash are still lurking in the shadows. A weakened economy can be quite problematic for both businesses and households. However, it’s not all bad. In fact, these relatively rare situations can be leveraged to accelerate the timeline to retirement.
In other words, a stock market crash can help investors potentially retire early. Here’s how.
A crash isn’t what people think
Two terms that are easily confused among newer investors are ‘price’ and ‘value’. And it’s essential to understand the difference between these in order to capitalise on the opportunities created by a volatile market. Simply put, price is what investors pay to buy a stock. But the value is how much those shares are actually worth.
During a crash, or even a correction like the one we’ve just experienced, the price is what ends up jumping off a cliff. However, there’s a giant question market surrounding what happens to value.
When shares are seemingly in freefall, investors, including professionals, often make irrational, emotionally-driven selling decisions. This is why stock prices can fall so rapidly. And it’s the precise behaviour prudent long-term investors love to exploit.
With everyone panicking about the end of capitalism, plenty of top-notch thriving businesses often get caught in the crossfire. And subsequently, a firm’s stock price could collapse despite the value actually increasing. And this is where the opportunities are created.
The stock market has a perfect track record of recovering from even the most catastrophic financial disasters. But the stocks with the biggest discrepancy between price and value are the ones with the most upward potential during a recovery. And it can even lead to double- or even triple-digit returns in the space of a year.
Investing during volatility
On paper, investing in undervalued enterprises sounds simple enough. But in practice, there are a few caveats to consider that complicate things. Most notable is not knowing when the panic selling will stop, and the recovery will begin.
Even if an investor successfully identifies the world’s greatest company trading at a massive discount, shares could easily continue to move in the wrong direction. This is where pound-cost-averaging enters the picture.
It’s impossible to know when a stock has hit its lowest point until after it’s too late to act. Therefore, a clever tactic is to simply drip-feed capital over time. That way, if the stock price continues to move in the wrong direction, it’s possible to snap up more shares at an even better price.
Unlocking early retirement
Using the stock market to build wealth is not a guaranteed process. A poorly constructed or managed portfolio can easily destroy wealth rather than create it. However, by taking a disciplined long-term approach and capitalising on bargains created during a crash, it’s possible to build quite a large nest egg.
Even if a portfolio matches the 8% market average return, investing £500 a month at this rate over 30 years could lead to a valuation of £745,180 when starting from scratch. And that could be more than enough to have a comfortable and potentially early retirement lifestyle.
