Thanks to the ongoing stock market correction, a wide range of cheap shares are available to buy today.
The volatility of stocks as inflation and interest rates rise does introduce new risks that investors have to tackle. Yet, in the long-term, the performance of undervalued businesses could be spectacular for patient individuals.
And with the right buying strategy, the risks of investing during volatility can be partially mitigated.
Buying during a stock market correction
Every week there seems to be a new record being broken for poor performance in the stock market. But underneath all this chaos, inflation has actually begun to reverse. August UK inflation dropped for the first time since this debacle began.
Assuming this trend can continue, we may be nearing the end of the downward stock market correction, even if share prices don’t yet reflect it. In other words, the window of opportunity to snatch up cheap UK shares may be closing.
Investing in businesses when prices are seemingly in free-fall is an understandably scary prospect. But as every other correction or crash has demonstrated in the past, fortunes are made in bear markets. Fortunately, there is a relatively simple buying strategy called Pound-Cost-Averaging that helps mitigate the risk of free-falling share prices.
Instead of trying to time the bottom of the correction, which is nearly impossible, I can break up my spare capital into smaller chunks. Then, each week, or month, I’ll drip-feed my money into the businesses I believe are the most undervalued.
What does this achieve? With so much volatility plaguing the markets, the chance of significant price drops, even in superb businesses, is elevated. I could only invest in seemingly cheap shares today to watch them get even cheaper next week.
Splitting up my capital into smaller chunks allows me to buy more shares in what I believe are excellent businesses at potentially lower prices. This lowers the average cost of my portfolio position, enabling potentially greater returns if and when the stock price eventually recovers.
Not everything recovers in the long run
From an overall perspective, the stock market has a 100% success rate of recovering from even the most disastrous of financial catastrophes. But when it comes to individual stocks, then things get murky.
As a long-term investor, the current economic climate is ultimately a short-term problem. And based on existing consensus, it could be resolved within the next two years. But that doesn’t mean it’s not having a tangible impact on businesses today.
Higher living expenses have already caused consumer spending to drop off a cliff, making growth for most industries rather difficult. Meanwhile, higher interest rates drive up the cost of servicing loan obligations putting further pressure on leveraged firms. And since many companies took on debt to survive the pandemic in 2020, the rate of insolvencies is rising.
Consequently, there are undoubtedly plenty of cheap shares today that are discounted for a good reason. That’s why, before making any investment decision, it’s critical to understand the financial state of the underlying business.
Suppose cash flow has become compromised, or margins are quickly tumbling. In that case, there’s a higher chance I could be looking at a value trap rather than a buying opportunity.