2022 was a rough year for many Stocks and Shares ISAs, especially those loaded with FTSE 250 stocks. The index is home to small- and medium-cap companies that were some of the worst hit during the recent stock market correction. And in the 12 months leading to September, the FTSE 250 tanked by as much as 30%.
Even today, after some solid upward momentum these past few months, it’s still firmly below pre-peak levels. However, that does mean the door to potentially lucrative recovery opportunities for patient investors remains open. And by using an ISA, any gains on successful investments would be tax-free.
Knowing the risks
It’s hardly a secret that buying high-quality stocks at discounted prices is a recipe for long-term wealth creation. But the uncertain near-term outlook for the British economy is understandably concerning. And the FTSE 250, along with other stock market indices, may be in for another tumble later this year.
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Most economists agree that the UK is heading into a recession. Given the cost-of-living crisis, energy price explosions, and rising interest rates, this isn’t really surprising. The question for investors is how severe this potential recession will be.
The Bank of England recently restated its expectations to be significantly more positive than initial estimates as a “soft landing” is looking more likely today. But as with any forecast, there’s never a guarantee. Depending on how long inflation continues to plague the economy, household budgets may set to get even tighter before things start to improve. And that’s obviously bad news for businesses both big and small.
Investing during volatility with a Stocks and Shares ISA, or any investing account for that matter, can be risky. Even buying the best UK stocks may be a poor investment in the short term. But what about the long term?
Navigating a bear market with an ISA
Over long-time horizons, the UK economy and stock market have a perfect track record of bouncing back from even the most severe declines. And for investors brave enough to buy shares during a bear market, there’s a lot of wealth to potentially unlock.
But just because the market as a whole tends to do well, that doesn’t mean every stock will do the same. In fact, an investor just loading up their Stocks and Shares ISA with the most beaten-down businesses will likely be horrified by the results.
While unfavourable macroeconomic environments are temporary, their effects can be permanent if a company isn’t equipped to handle them. Poorly funded operations with unreliable cash flows could see performance suffer greatly if consumer spending continues to slow. This risk is only amplified by firms with a high degree of financial leverage.
Therefore, investors must investigate why a stock price has been hit so hard. Suppose it’s a matter of panicking investors simply selling off shares to protect capital. In that case, a high-paying buying opportunity may have emerged. But if there’s a fundamental flaw in the business, it would likely be prudent to steer clear.
