Buying bargain stocks could prove to be a risky strategy over the coming months. Many industries face hugely challenging operating conditions across the world economy that may persist over the short run. As such, the stock market's performance could be somewhat disappointing after its recent market crash.
However, investors with long-term time horizons could benefit from the wide margins of safety currently on offer. There may be favourable risk/reward opportunities across many sectors that lead to impressive long-term returns. They could boost your financial prospects and help you to retire early.
A wide margin of safety
Buying bargain stocks may allow you to access more attractive risk/reward opportunities. In some cases, low valuations are merited at the present time. For example, companies trading in sectors such as retail and travel & leisure could experience difficult trading conditions that negatively impact their financial performances. However, in other cases weak investor sentiment towards the wider stock market means that you can buy high-quality businesses at a large discount to their intrinsic values.
A strategy of buying undervalued stocks has historically been highly successful. The stock market has never experienced perpetual bear markets, with it having produced high single-digit annual returns despite a number of downturns, crashes and bear markets. Through buying stocks when they offer wide margins of safety, investors can benefit from the cyclicality of the stock market, as well as its recovery potential.
Relative appeal of bargain stocks
It may be tempting to ignore bargain stocks at the present time due to the uncertain economic outlook. Investors may even decide to focus their capital on lower-risk assets such as bonds and cash. They may outperform the stock market should it experience a further crash in the coming months due to challenges such as a weak economic outlook or a second wave of coronavirus.
However, over the long run a portfolio of stocks is very likely to beat the returns of cash and bonds. That's especially the case since the prospects for a hawkish monetary policy, where interest rate rises are commonplace, seem to be low. Policymakers may look to provide support to the wider economy through lower interest rates, which could cause the performance of bargain stocks to be significantly more attractive than the returns available from other popular assets such as cash and bonds.
A long time horizon
Therefore, investors with a long time horizon could improve their retirement prospects through buying bargain stocks today. Certainly, they may not produce paper gains over the coming months due to the uncertainties facing the world economy. However, over the long run the favourable risk/reward opportunities available due to weak investor sentiment and the growth potential of the world economy mean that they may help to bring your retirement date a step closer.
