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When the stock market falls, that can seem like bad news to investors.
The reality, however, is that a stock market crash can be bad or good depending on how we react to it. For a savvy investor, a stock market correction or crash can offer the opportunity to buy shares of great companies at a lower price than before.
For now, the stock market continues to perform well. The UK flagship FTSE 100 Index The index has hit an all-time high this year. It is currently about 2% below that all-time closing high.
But sooner or later, as history shows us, there will be a correction in the stock market. Here's how I would use it to try and turn a sum of £30,000 into a portfolio worth £1 million in the future.
Taking advantage of low prices
Let's say I invest in a stock portfolio that grows in price by an average of 5% per year and has a dividend yield of 7%. That equates to a compound annual gain of 12%.
Now let’s imagine that a stock market correction causes that stock pick to drop 15%. If I buy then, that 5% annual gain will end up being a 5.75% annual gain thanks to my lower purchase price.
Meanwhile, the average dividend yield would not be 7% but 8.05%, again thanks to my lower purchase price. Therefore, my compound annual gain in price would be 13.8%.
This is where the long-term benefit of compounding really comes into play. If I compounded £30,000 at 12% per annum, my portfolio would be worth over £1m after 31 years. However, at the highest rate of 13.8%, it would take 28 years to reach the £1m mark.
Preparing now to hunt for bargains in the future
Remember that this example assumes I spend the same amount buying the same stocks. The only difference between the two scenarios is that in one I buy before a 15% price drop and in the other, after. In a stock market correction, some individual stocks can fall much more than that, giving me even more room to pick up bargains.
But just because a stock is falling doesn't mean it's cheap.
I still have to focus on quality and in the midst of a market crisis, I may not have enough time to do research. That's why I'm updating my list of stocks to watch. nowto prepare to act when the next stock market correction hits.
A name in it is M&G (LSE: MNG).
During the 2020 stock market crash, M&G’s share price fell dramatically. If I bought it today, I could get an already juicy 9.5% return. But if I had bought it at its 2020 low, I would now be getting a return of over 18% per year!
With a customer base of millions, continued strong demand for asset management, and a strong brand, I believe the firm is poised for continued success. One concern is what the firm called this month “high“geopolitical risk that threatens economic stability and investor confidence.
But, if the next stock market correction allows me to buy more M&G shares at a bargain price, I plan to do so!
