The FTSE 100 has delivered a strong recovery following the 2020 stock market crash. Although it continues to trade 13% down on its price from a year ago, it is nevertheless around 30% up on the lowest point it reached in the March 2020 crash.
Despite the recent stock market rally, a number of companies continue to trade on low valuations relative to their historic averages. Buying a wide range of them for the long term could lead to impressive returns. Meanwhile, holding some cash in case of a further market decline may be a prudent move.
Buying cheap FTSE 100 shares today
Clearly, some FTSE 100 stocks now trade at relatively high prices. Investor sentiment has improved significantly as vaccine rollouts have continued and economic forecasts have improved.
However, this does not mean that further gains for the index are necessarily ahead. As the 2020 stock market crash showed, investor sentiment can very quickly change from positive to negative. As such, it may be a sound idea to only purchase companies with valuations that have not run away to levels that are difficult to justify. For example, buying stocks with margins of safety relative to their sector peers or historic averages could be a prudent move.
After the FTSE 100’s recent stock market rally, such a task may be more difficult than it was just a few months ago. However, as mentioned, the index continues to trade down on its level from a year ago, and some sectors such as property, financial services and retail could offer good value for money at the present time.
Holding cash in case of a stock market crash
The track record of the FTSE 100 highlights how unpredictable its performance can be. Certainly, it has produced high single-digit annual total returns since its inception in 1984. However, along the way it has experienced numerous stock market crashes, corrections and bear markets that have caused major declines in a short space of time.
Such events have not suddenly become obsolete. They are very likely to occur in future, although predicting when they will take place is a very difficult task. Therefore, taking a prudent approach and holding some cash in a portfolio could be a sound move. It may provide peace of mind should the current stock market rally turn into a crash. Moreover, it could allow an investor to capitalise on low valuations caused by a sudden deterioration in investor sentiment over a short time period – as was the case in March 2020.
Holding some cash instead of being fully invested in FTSE 100 shares may produce lower returns than those available in the stock market. However, over the long run such a strategy may be beneficial in terms of accessing low stock prices in a future stock market crash.
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.