The idea of buying cheap shares may seem less appealing after the COVID-19-led stock market crash. It highlighted the volatility that can be present in the stock market over short time periods, as well as the paper losses that can be incurred by any investor.
However, over the long run, purchasing undervalued companies could be a profitable move. It is a strategy that has been used to great effect by Warren Buffett. He has used market downturns to his advantage over many years.
As such, avoiding popular assets such as Bitcoin and gold to buy bargain stocks may be a sound move despite heightened short-term risks.
The appeal of cheap shares
Cheap shares can sometimes be priced at low levels because they offer disappointing investment outlooks. For example, they may have high debt levels or a weak strategy that is in need of major change.
However, in some cases undervalued stocks can offer significant recovery potential. Their prices may be suffering because of weak industry conditions that ultimately give way to growth. Similarly, investor sentiment may be weak due to an uncertain economic outlook that gradually evolves into growth over the long run.
Warren Buffett has consistently purchased cheap shares after bear markets. This has enabled him to buy high-quality businesses at low prices. Over time, they are likely to recover to post impressive gains. As such, with many strong businesses currently in a similar situation, now could be the right time to capitalise on their low prices to improve your long-term financial prospects.
Of course, cheap shares could fall in price in the short run. Risks such as political uncertainty in the US and coronavirus may mean that investor sentiment declines even further in the coming months. This may negatively impact stock markets and put share prices under greater strain.
As such, it is imperative that investors follow Warren Buffett’s lead and adopt a long-term timeframe when buying shares. It may take some time for industry operating conditions and investor confidence to return to 2019 levels. By allowing your portfolio the time it needs to recover, you can fully benefit from a likely resurgence in global economic growth and in the performance of the stock market.
Avoiding gold and Bitcoin
Short-term risks to cheap shares may persuade some investors that now is the right time to buy other assets such as gold and Bitcoin. However, gold’s high price means there may be limited scope for a similar rate of growth to that experienced so far this year. Moreover, improving investor sentiment towards risky assets such as shares may reduce demand for defensive assets such as gold, thereby negatively impacting on its performance.
Meanwhile, Bitcoin’s lack of infrastructure and regulatory risks mean that it may fail to deliver on investor expectations over the long run. It may underperform a portfolio of undervalued shares, while being a riskier means of planning for retirement. Therefore, following Warren Buffett’s advice and buying a portfolio of stocks could be a more prudent means of improving your long-term financial outlook.
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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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