A stock market crash can cause significant paper losses for investors, as stock prices decline to low levels. This may encourage many investors to avoid buying stocks, or even to sell their current holdings. But it could also be an opportunity to buy high-quality businesses while they trade at low prices.
In fact, the past performance of the stock market shows it’s always experienced downturns. However, they’ve been followed by recoveries that may boost your financial outlook and increase your chances of making a million.
Low prices in a market crash
Most investors would rather buy a company when it trades at a low price, rather than at a high one. The problem, though, is that low stock prices are usually associated with a highly uncertain future for the company in question. This may dissuade investors from buying stocks. Instead, they may feel it’s better to buy when the outlook for a company, or the wider economy, is more stable.
However, buying stocks when they trade at low prices is a means of improving your portfolio returns. Purchasing a company when it trades at a wider discount to its intrinsic value naturally provides greater scope for capital gains. Therefore, when stock prices are cheap during a market crash, they could offer greater return potential for long-term investors.
One reason why many investors may fail to buy stocks when they’re cheap is a fear they won’t recover from the difficult operating conditions faced in the short run. However, the stock market’s past performance shows that a turnaround from even the very worst bear markets is highly likely over the long run. The stock market has always recovered from its various crises over the years to post new record highs.
This process can take several years in the case of severe recessions, such as the global financial crisis. But investors who hold high-quality stocks over the long run are likely to see prices recover. Therefore, through adopting a long-term view and buying stocks during a market crash, you can increase your potential rewards.
Stock market crashes caused by economic difficulties can strengthen the relative positions of high-quality businesses. Companies with solid balance sheets and wide economic moats may emerge from an economic downturn with a larger market share than their peers. This is due to smaller competitors becoming insolvent.
Buying the best businesses within a specific sector during a market crash may, therefore, allow you to capitalise on their improving earnings outlook over the long term. Certainly, their financial prospects may decline in the short run. But they could deliver higher returns in future than they have done in the past. And that can improve your prospects of generating a seven-figure portfolio over the long term.
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.