Any quick glance at a historical chart will show me that a stock market recovery always happens eventually, even after the worst financial crises. While watching my portfolio plummet is a gut-wrenching experience, such events aren’t all that common. For example, there have only been three crashes in the last 20 years.
But as horrible as they are to experience, a market crash creates opportunities to buy dirt-cheap shares in fantastic companies. Needless to say, I think being able to buy shares at bargain prices, is a brilliant recipe for building wealth.
A stock market recovery from Covid-19
The FTSE 100 has already begun recovering since the crash in March 2020. Yet even today it still trades 15% lower than its pre-Covid levels. And last month’s tumble may have extended the stock market recovery time.
But with so many businesses now adapted to the pandemic operating environment, I would expect some companies’ share prices to be higher than they currently are. In other words, I think there are still multiple dirt-cheap shares worth buying.
It’s impossible to know when the stock market recovery will be finished. And until that time, the level of market volatility is likely to remain high.
However, historically market levels tend to return to pre-crash prices after around 18 months. This historical average would indicate that the market might get back to pre-Covid levels later this year. What’s more, indices like the FTSE 100 typically reach new highs directly after recovering from a crash. Meaning dirt-cheap shares today, could appreciate in price dramatically over the next few months.
They might not, of course. Just as the pandemic has been different from anything most of us have seen in our lifetimes, it may also rewrite the rules on stock market recovery times. And some companies may never bounce back. So I would never make assumptions that every cheap stock out there is a real bargain. Careful research remains as important as it ever was.
Using dirt-cheap shares to build wealth
There are many investment instruments that can be used to try to build wealth. Historically, cash and bonds were a great way to generate a reliable income with minimal risk. But with interest rates now near zero, the returns on high-quality bonds can barely keep up with inflation.
Since interest rates aren’t likely to go back up any time soon, equities may become more appealing to even more investors. And when the demand for equities go up, so does market liquidity which hopefully further accelerates a stock market recovery.
While riskier than some other investments, stocks have historically generated the greatest returns of any investment instrument over the long term. So when I see a fantastic business’s share price plummet during a crash, I see it as a buying opportunity I don’t want to miss. After all, the cheaper the stock, the more room for growth.
But beware! Sometimes a stock is dirt-cheap for a good reason. Even a talented analyst like Warren Buffett can miss the most vital details that can change the fate of a business (look at what happened with Dexter Shoe Co).
That’s why I think diversification is an essential tool for my portfolio. It helps mitigate these risks and protects wealth while it grows.