Is a stock market crash good or bad for an investor who is trying to build up a retirement pot and even hoping to retire early?
The obvious answer may seem to be ‘bad’. A crash can wipe four, five, or even six figures off the valuation of a retirement fund in a short time, depending on how big it is.
But, while seeing a valuation plummet is understandably concerning, that is only a paper loss.
Given the long-term nature of investing for retirement, it is possible (though certainly not guaranteed) those losses will be reversed by the time someone wants to sell those shares and help fund their retirement.
For the investor who reacts in the right way, a stock market crash could actually help them build up the value of their retirement fund, so they could potentially retire early – even years early.
Turning into a crisis into an opportunity – to retire early!
Understanding how that can work in practice is quite simple.
Typically, a stock market crash sees widespread share price falls across much of the market. I think we can break them down into three types.
First, shares that have been overvalued lose much of their hype value. They do not necessarily become cheap, though: they just get closer to a realistic valuation.
For example, Computacenter is a solid, proven business.
But an investor who bought at Computacenter’s peak before the dotcom stock market crash in 2000 would have been nursing a paper loss for two decades until the price finally recovered in 2020.
Secondly, shares in businesses whose underlying value falls as part of (or leading up to) a stock market crash.
Think banks in 2007 as an example. Lloyds and Natwest have been on fire in recent years – but neither has ever got anywhere close to their price before the financial crisis.
A third type of share price fall is one where a crash basically indiscriminately punishes a share to the point that it becomes a bargain. This is the opportunity!
Dialling up the dividend yield
For example, consider FTSE 100 asset manager M&G (LSE: MNG).
The share’s 6.5% dividend yield is well over twice the FTSE 100 average. On top of that, the company aims to grow its dividend per share annually.
Whether it can do that depends on how much spare cash it generates. Its most recent dividend raise was slender.
For some years the company has struggled to have clients put more in than they take out, risking profits. Its most recent results showed positive progress on that front, but it remains a risk.
But here’s the thing. With a strong brand, millions of clients, and a proven business model, M&G has a lot going for it. That was also true in 2020.
That year, though, the stock market crash sent its price tumbling.
The M&G share price is up 184% since May 2020. So someone who invested back then would not now be earning the already juicy 6.5% yield, but a whopping yield north of 18%!
A portfolio ought always to be diversified. But, as an example, compounding a £100k SIPP at 6.5% annually, it would take 26 years to reach £500k. Compounding the same amount at 18%, it would be worth £500k after just a decade!
