With the FTSE 100 around 11% lower over the past month or so, on this side of the pond at least we are in the territory of a stock market correction (a drop of over 10% in short order) rather than a full-blown crash (20% or more).
Even a stock market correction can be unnerving, as many investors see thousands of pounds wiped off the value of their holdings in days. But a crash can be a lot scarier, as we have seen in the past.
Still, a stock market crash can actually provide many people with one of the better investment opportunities of their lifetime and help them retire early. Here’s how.
A crash can throw up huge bargains
Often when there is a stock market crash, a large number of shares fall steeply in value.
For some of them, that makes sense. They may have been overpriced before, or it could be that the cause of the crash is something that will affect their business directly.
An example of that was banks during the 2008 financial crisis. Even now, the Lloyds share price is 78% lower than where it started 2007, for example.
But a crash can also push down the price of a lot of other shares for no specific reason. That means it can throw up what turn out, with hindsight, to be tremendous bargains.
Buying quality on the cheap
In the moment, it can be hard to tell whether a company will suffer over the long term from the cause of a crash.
But buying the same share when it is much cheaper than before (or afterwards) can make a significant impact on the long-term performance of an ISA or SIPP.
As an example, consider British American Tobacco (LSE: BATS). Even after a recent price fall, it is still now 27% costlier than it was during the last UK stock market crash, in 2020.
As well as the impact on price, that has an impact on yield. The yield now is a tasty 7.7%. But an investor buying during that 2020 crash could now be earning a 9.7% yield.
That might not sound like a big difference. But compounding £1,000 at 9.7% for 20 years would turn it into £6,254. Compounding at 7.7% it would take five years more to achieve the same amount.
On a larger scale with a big enough portfolio, then, a seemingly small difference in yield could mean an investor being able to hit their retirement income target years early.
Numbers are only one part of this: quality matters too. British American is a FTSE 100 company that owns premium brands like Lucky Strike. It has a large customer base, distribution network, and proven business model.
It has grown its dividend annually for decades. However, tariffs are just one of the risks to profits at a firm whose reliance on the US market is so large that it includes “American” in its name. The long-term decline of cigarette smoking in many markets is also eating into sales volumes and threatens profits.
Getting the right risk between risks and rewards is essential for an investor. I think income investors should consider British American. By buying a mixture of quality shares at bargain prices in a stock market crash, retirement could come early!
