The prospect of a stock market crash could cause concern for many investors. This is understandable, since no investor wants to see their holdings decline in value – even for a short period.
However, most investors are net buyers of stocks. In other words, they’re not seeking to sell their holdings for a profit in the near term. Rather, they are adding to their portfolio, either through the reinvestment of dividends received, or from adding new capital to it.
Therefore, a market crash may allow such investors to take advantage of lower valuations that ultimately lead to higher returns in the long run. This means a market crash may be an event that helps to build your retirement nest egg.
Market crash potential
There’s always the potential for a market crash. Geopolitical risks can rise suddenly and without warning to cause investor sentiment to decline rapidly. As a result, the stock market is permanently susceptible to sharp declines in its value that are unexpected by all investors.
Alongside this, the outlook for the world economy in 2020 seems to be highly uncertain. Factors such as Brexit, US political change and a slowing in the growth rate of major economies across Asia could combine to produce a less favourable operating environment for FTSE 350 stocks. This may lead to declining investor sentiment, and a challenging period for shares after they have posted gains for over a decade.
As mentioned, most investors are net buyers of shares. They are looking to build a portfolio to pay for their retirement, or to eventually provide a passive income in future. Therefore, from a logical standpoint, buying shares at lower prices is a better idea than buying them at higher prices. It offers greater potential for capital growth, and could lead to higher annualised returns.
A stock market crash presents an opportunity to achieve that goal. For shares in high-quality businesses to trade on low valuations that represent a discount to their intrinsic values, there usually needs to be significant risks facing their future financial prospects. History shows that market crashes provide such opportunities, with long-term investors who can capitalise them generally enjoying high returns as a consequence.
Of course, buying shares during a market crash is not an easy process. It requires an investor to ignore the short-term challenges facing the economy and, instead, to look ahead to the prospect of a recovery over the long run.
Since major indexes such as the FTSE 100 and FTSE 250 have always recovered from their downturns to produce successful turnarounds, a similar performance is likely following a future market crash. As such, investors may wish to gradually hold back some cash over the medium term in preparation for a market crash. Doing so could provide them with a buying opportunity that improves their long-term financial prospects.
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Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.