The US stock market has entered correction territory, which gives investors something to think about. All of a sudden, the shares they own are worth less than they were a few weeks ago.
At times like this – or in a full-blown crash – investors need a strategy for long-term success. And mine draws inspiration from some unusual sources.
Defending
The undefeated 2003-04 Arsenal football team is probably the best in Premier League history. And that’s not fun to admit as a Spurs fan who grew up watching Arsenal when the team was dubbed the Invincibles.
But even the Invincibles had to go through some difficult times. They had to defend and there were times things didn’t go their way – but they persevered and refused to be beaten.
I think this is true of virtually everything in life, including investing. Challenges are inevitable, but being willing to show the character to not give up in tough times is crucial to success.
In the stock market, even the best and most resilient companies have times when their shares come under pressure. Rolls-Royce (LSE:RR) is a great example.
The stock fell 77% at the start of the pandemic as travel demand evaporated, earnings turned negative, and debt increased. That can’t have been much fun for investors at the time.
Those who sold, however, missed out on a recovery from the business that sent the stock up 1,300%. Being able to hang in there when the pressure is on is key to those long-term returns.
Seizing the opportunity
Avoiding the temptation to sell when prices are falling is essential when it comes to the stock market. But the best investors are able to do more than this and buy when shares are cheap.
One way of being able to do this involves keeping cash in reserve. But this isn’t an approach that I like – I think the risk of prices rising sharply makes this a risky strategy.
There is, however, another way to take advantage of a stock market correction. And that involves taking a look at which shares have fallen more than others.
As an example, Adobe (-15%) has fallen much more than Microsoft (-4%) over the last month. As a result, investors might wonder whether selling one to buy the other is a good idea.
The question isn’t straightforward – it depends on whether artificial intelligence is a long-term threat or an opportunity for Adobe. But there is now a significant difference in valuation.
The general point, though, is that buying shares when prices are low doesn’t depend on holding on to cash and waiting for a crash. Reassessing a portfolio can reveal opportunities.
Investment opportunities
I’m mindful that selling because a stock might go lower is almost always a mistake. But so is holding on to a good investment if it comes at the cost of not being able to make a great one.
Returning to Rolls-Royce, I wonder whether investors who own the stock might consider selling to invest elsewhere. The company is expecting to reach £4.5bn in free cash flow in 2028.
At today’s prices, that implies a return of around 6.5% and this is still three years away. A volatile stock market across the Atlantic means there could be better opportunities available.
