A lot of investors have been nervous about the stock market lately. In fact, although some US tech stocks have seen big falls, the UK FTSE 100 index is actually 4% higher today than it was a year ago. Still, a worsening economic outlook could yet lead to a stock market crash at some point.
Such an event can be scary – but also a massive opportunity. Here is how I could use a stock market crash to try and bring my retirement forward — by years.
What happens when the stock market crashes
A common definition of a stock market crash is a decline of more than 10% from a recent high.
Does that mean that as an investor I would lose money in a crash? No, it does not – unless I sell my shares. If I sell the shares for less than I paid for them, I would have lost money. But if I do not sell what I own, only the paper value of my portfolio has changed. If share prices recover in future, that paper value ought to increase again. That is not guaranteed to happen.
So although a lot of people fear a stock market crash, what it actually means for you depends on how you react.
For me, I would see a crash as a chance to improve my investment returns. That could help me retire early.
Buying the same, but cheaper
That is because falling prices give me the chance to buy the same thing I could have bought a few weeks or months earlier, but paying less for it.
If I invest in income shares, that will often mean that I can get a higher dividend yield from a share than before because the price has gone down. As an example, consider Direct Line. Its shares have fallen 30% over the past year. That means, I can buy it today with a yield of 11.3%, whereas buying the same shares 12 months ago would have offered me a yield of 8.7%.
Imagine I spent £10,000 on such shares now and compounded the returns from my dividends for 20 years. At the end of that period, my investment would be worth £94,800. But if I had spent £10,000 on Direct Line shares a year ago and compounded the dividends in the same way, it would take me another six years to reach the same value.
Using a stock market crash to my advantage
In the example I used above, I presumed a constant share price and dividend. In reality that is unlikely to be the case. I also would always ensure my retirement portfolio was diversified across a range of companies and business areas.
But the principle applies more broadly. Simply by investing the same amount of money in the same companies at a time when their shares have been marked down in price, I could hit the financial target I have for retirement years earlier.
That is why the action I am taking right now is to make a watchlist of companies I would like to buy in the next stock market crash.