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Image source: The Motley Fool
As an investor, are stock market corrections good or bad?
On paper, it might seem like bad news. The value of a portfolio can decline, sometimes dramatically, in a short period of time. But the correction also provides an opportunity to buy shares in large companies at lower prices than before.
With patience – which I think is an important attribute when it comes to long-term investing – I think the next stock market correction could help me double my money. Whether it comes in 2023 or later, I am preparing now by looking for stocks that I wish I could buy at a good price.
Change the value
Imagine someone knocking on your front door every day and telling you the price of their car. Not only will they buy a car for that price, they will sell the same car to that person for that price.
Perhaps one day the price offered is so high that the leftover money can be used to buy another car. Other days the price may be very low, meaning a replacement car at a low price is the only option.
Something is not right about that example. Everyday cars are the same. How about 5%, 10% or 20% more or less than a few weeks ago?
Mr. Market
In fact, the fundamental value of the car may not change at all. But what people are willing to pay (or part with) can change.
This 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 investors every day at a certain price.
But while stock prices may fall — as much as 20% in a short period of time, according to the popular definition of a stock market correction — the company’s fundamental value may not change much, if at all.
Opportunity knocks
That gave me an interesting opportunity.
By putting money in when the stock price is lower than before, I should be able to increase the returns I get.
Take for example one of the stocks in my portfolio, an asset manager M&G. If I buy today, I can make a profit of 9.6%. That has been highly attractive to me. But in the March 2020 stock market correction, I was able to buy the stock at a lower price.
The price difference only means that once I have invested, I will now have a paper profit of 72% on the share price. But investing at a lower price also means that I will now get a 16.6% yield on M&G shares.
Such returns, if compounded, would allow me to double my money in just five years (at a constant stock price). Even without compounding, I will double my initial investment in less than seven years from dividends alone.
A stock market correction can see all sorts of quality companies marked down in price. Jumping at that opportunity – in different stocks – hopefully will help me double my money.
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