The recent volatility in the FTSE 100 may have caused disappointment for a number of investors. Their portfolios may now be worth less than they were a few months ago, and they may be questioning the future prospects for the wider stock market.
However, such periods can offer the opportunity to profit in the long run. Warren Buffett has been quoted as advising investors to “look at market fluctuations as your friend rather than your enemy.” And by doing so it may be possible to beat the FTSE 100 and generate high total returns in the long run.
Margin of safety
While the FTSE 100 has declined by around 10% in recent months, its long-term outlook has not changed significantly. The prospects for the world economy continue to be bright, with GDP growth expected to be relatively high as rising spending and lower taxes in the US could have a positive impact on global growth.
Certainly, those very same policies in the US could lead to higher inflation. This may cause a faster rate of rise in interest rates over the coming years. However, with confidence remaining high and policymakers seemingly unlikely to raise interest rates rapidly owing to fears of hurting the economic growth outlook, investing today seems to be a shrewd move.
As such, it is now possible to buy the same stocks with very similar outlooks at prices which are 10%+ cheaper than they were three months ago. They now offer a wider margin of safety, which helps to tilt the risk/reward ratio further in favour of the investor.
Further challenges
Warren Buffett has also commented on the difficulties experienced by the US economy during the 20th century. He is reported to have said that “the US endured two world wars and other traumatic and expensive military conflicts, the depression, a dozen or so recessions and financial panics, a flu epidemic and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.”
In other words, Buffett is stating that economies experience major shocks on a relatively regular basis, but yet are still able to generate strong growth. This is reflected in higher share prices, with the FTSE 100 rising seven-fold since its inception in 1984. This is despite challenges such as the 1987 crash, the ERM crisis in the early 1990s, the dotcom bubble and the credit crunch.
As such, the recent volatility which has been present in the stock market is recoverable, and investors can take advantage of such fluctuations through buying on dips in valuations. While doing so could mean paper losses and challenges in the short term, it could lead to long-term investment success.
While equalling Warren Buffett’s level of success may not be possible, beating the FTSE 100 could be a realistic goal for a wide range of investors.