What would a stock market crash mean for your portfolio? Some people worry it could mean they have to work even longer. However, a crash can actually help a well-prepared investor retire early – even years earlier than planned.
Focusing on what, not when
I do not know when the market will next crash. Nobody does. But what is clear from history is that, sooner or later, it will.
Rather than fixating on when that might happen, I think a more productive use of an investor’s time now can be getting ready by deciding what to do when it does.
After all, it could open a big window of opportunity. It might not last long, so readiness is key.
Buying great shares at bargain prices
It helps to understand what is going on when the stock market crashes. Typically, there is some proximate cause, or causes. The underlying prospects of a sector may have changed, for example.
Take the 2008 financial crisis as an example. Banking shares nosedived – and for good reason. The prospects for the sector suddenly looked much worse than before.
So while Lloyds’ shares have almost doubled in the past five years, they are still 68% below their 2007 peak (which in turn was already far below where the share stood back in 1999).
But a crash can often send down the price of shares whose underlying business prospects seem largely unchanged – and that can be an opportunity.
Used the right way, it can even be an opportunity that ultimately helps the savvy investor retire early.
Same dividend, different share price = different yield
That is because of the difference in dividend yield a share offers depending on the purchase price.
Take asset manager M&G (LSE: MNG) as an example. It currently pays 20.5p a year in dividends. It aims to grow that amount annually and has been doing do, though no payout is ever guaranteed.
The current share price of M&G means that someone buying today can earn a yield of 6.7%. That is already tasty and well over double the FTSE 100 average.
But someone buying in the March 2020 stock market crash paid much less for M&G shares. The share price has risen 175% since, making for a tidy capital gain.
What about dividends though? The simple arithmetic of dividend yield means that someone buying into M&G at that far lower price in 2020 would now be earning a yield of over 18%.
Compound a retirement portfolio at 6.7% and it will take 11 years to double in value. By contrast, compounding it at 18% annually should mean it doubles in just five years.
Here’s how I’m preparing now!
I still think M&G is an attractive business. It has millions of customers, a strong brand and proven cash generation potential underpinning that above-average yield.
But there are risks too. I fear current market instability could see investors withdraw more from M&G funds than they put in, eating into earnings.
I think M&G merits consideration even now. But if I could buy a diversified range of blue-chip shares like it at much lower prices during a market crash, that could potentially give me the opportunity to retire early.
