Investors have experienced a highly volatile stock market so far in 2020. Looking ahead, risks such as a continued rise in the number of coronavirus cases and geopolitical uncertainty in North America and Europe could contribute to continued heightened fears among investors.
Therefore, it may become increasingly important to build a diverse portfolio of high-quality businesses with sound finances when seeking to make a million. Furthermore, holding some cash may enable you to capitalise on temporary declines in stock prices that may occur over the coming months.
Diversification in a volatile stock market
Diversification is always a key part of investing, but may become even more crucial in a volatile stock market. Share prices could come under significant pressure across many sectors over the coming months. Therefore, if you own a wide range of businesses, the impact on your portfolio’s performance from disappointing returns among a small number of holdings is unlikely to be extreme.
With the cost of sharedealing having fallen over recent years, it is now possible for the vast majority of investors to buy a wide range of shares in order to diversify. Diversification may also boost your returns through allowing you to take advantage of the growth opportunities in a wider range of sectors at a time when it is difficult to predict which industries will prosper in a post-coronavirus world.
A volatile stock market may also mean that investing in financially-sound businesses becomes more important. Over the past decade, companies with weak balance sheets and questionable business models have often survived due to strong economic growth being present.
However, with the economy’s outlook being weak and consumer sentiment being at relatively low levels in many countries, only the strongest companies may prosper over the coming years. As such, focusing your capital on those businesses that have modest debt levels, strong cash flow and wide economic moats could prove to be profitable. They may not be among the cheapest shares around, but their higher quality versus sector peers could make them more attractive on a risk/reward basis.
Holding some cash in a volatile stock market could be a sound move. Of course, low interest rates mean that cash is unlikely to offer a high return over the long run. It could even reduce your spending power over the coming years if inflation moves higher. Therefore, relying on it to boost your chances of making a million is not a sound idea.
However, an uncertain economic outlook means that a second market crash cannot be ruled out. This may present more attractive buying opportunities over the coming months that can be capitalised upon by investors who hold cash today. Buying high-quality stocks at even lower prices may increase your prospects of obtaining a seven-figure portfolio.
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Motley Fool contributor Peter Stephens has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.
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