As an investor, is a stock market correction good or bad news?
On paper, it can be look like bad news. The value of a portfolio can go down, sometimes dramatically, in a short period of time. But a correction also gives me an opportunity to buy shares in great companies at cheaper prices than before.
With patience – which I think is an essential attribute when it comes to long-term investing – I reckon the next stock market correction could help me double my money. Whether it comes in 2023 or later, I am preparing now by searching for shares I would like to own if I could buy them at a good price.
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Changing value
Imagine that every day someone knocked at the front door and named a price for the owner’s car. Not only would they be willing to buy the car at that price, they would also be willing to sell the individual an equivalent car at that price.
Perhaps one day the price offered is so high that it could be used to buy another car with money left over. On another day the price may be very low, meaning a replacement car at a bargain price is the only option.
Something does not sound quite right about that example, though. The car is the same every day. How could it be worth 5%, 10% or 20% more or less than it was just a few weeks before?
Mr. Market
In fact, the underlying value of the car may not really have changed. But what people are willing to pay for it (or part with it for) can change.
That is how the stock market operates. As Ben Graham describes it – an analogy adopted by Warren Buffett – Mr Market offers to buy shares from or sell shares to an investor each day at a certain price.
But while a share price may have fallen – by 20% in a short period of time, according to a popular definition of a stock market correction – the underlying value of the company may not have changed much, if at all.
Opportunity knocks
That presents me with an interesting opportunity.
By putting my money to work when share prices are lower than before, I should be able to improve the returns I get.
Take as an example one of the shares in my portfolio, asset manager M&G. If I bought it today, I could earn a dividend yield of 9.6%. That is already highly attractive to me. But in the March 2020 stock market correction, I could have bought the shares at a lower price.
The price difference alone would mean that having invested back then, I would now be sitting on a paper gain of 72% in share price value. But investing at that lower price would also mean that I would now be earning a 16.6% yield on my M&G shares.
Such a yield, when compounded, would let me double my money in just five years (with a constant share price). Even without compounding, I would double my initial investment in under seven years from dividends alone.
A stock market correction can see all sorts of quality companies marked down in price. Jumping on that opportunity — across a variety of shares — could hopefully help me double my money.
