The idea of working decade after decade only to see the value of one’s pension eaten away by high inflation is disheartening. But a worsening economy is not bad in all ways when it comes to retirement planning. In fact, I think a future stock market crash could help me retire early. Here is why.
What a stock market crash really is
Investors often confuse two things.
The price of a share is the money you need to pay for it. The value of that share is what it is really worth, based on the likely future performance of the business.
A stock market crash is a sudden, sizeable drop in the price of shares. But critically, it is the share prices in the market that have crashed. What about the underlying value of those businesses?
In some cases, the factors that lead to a market crash may hurt the underlying value of a firm. For example, in the last financial crisis, the price of bank shares like Lloyds fell sharply. But the value of those businesses also fell, as the risk of mounting loan defaults meant their profits would be lower in future.
Is that true of all businesses in a stock market crash? I do not think so. Some see their share prices decline even though the long-term potential of the business is still fairly strong.
That gives me an opportunity to retire early!
Tumbling price for similar value
Take as an example a share I bought in 2020 after its price had suffered a lot due to concerns about how the pandemic might impact its business — Legal & General.
On Valentine’s Day in 2020, while I may have loved the business, the share price was less attractive to me, at £3.18. Just a few weeks later, on 20 March, it had hit £1.57 – less than half of its old price.
Today the Legal & General annual dividend is 18.45p per share. So if I had bought in February 2020, my current dividend yield would be 5.8%. If I had bought the same share only a few weeks later when the stock market crash had pummelled its price, my yield now would be 11.8%.
If I compounded my dividends annually after buying the shares, I could have doubled my money within six years. Buying before the crash, reaching the same point would have taken me 12 years. That presumes constant share price and dividends, but the point is clear that a lower price can equal higher yield.
By taking advantage of quality shares that see their prices marked down in a stock market crash, I could knock years off how long it takes me to hit my investment goals — and retire early!
Buying quality on sale
Hindsight is a great thing. But some businesses that saw their share prices crash in 2020 never really recovered. Legal & General did, but that was not a sure thing in 2020.
So I am not aiming to retire early simply by buying shares that tumble in price during a stock market crash. Instead, I keep focused on finding great companies in which I could invest. Then, if their share prices become even more attractive due to a stock market crash, I could load up my portfolio. Hopefully that might let me retire at a younger age.
The post Retire early thanks to a stock market crash? Here’s how appeared first on The Motley Fool UK.
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C Ruane has no position in any of the shares mentioned. The Motley Fool UK has recommended Lloyds Banking Group. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.