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When the stock market enters a period of volatility, as it has done over the past several months, it can be a scary time for investors.
Portfolio values can suddenly drop dramatically. For a long-term investor, that may not matter – after all, a paper loss is only a paper loss.
But psychology can be powerful and it is not always easy for investors to ignore rapid falls in share prices.
Is stock market turbulence necessarily a bad thing though?
No. In fact it can be a way for the long-term investor to grow their wealth faster, potentially allowing them to retire earlier than planned further down the line.
One situation, two great wealth-building opportunities
There are a couple of reasons for that.
One is that a suddenly lower share price can mean better potential for long-term capital gain.
Take WPP (LSE: WPP) as an example. The advertising giant’s share price was above £12 in February 2022. Lately, the share has been selling for under £6.
So, imagine (just for the sake of illustrating the point) that at some point in future, the share price hits £24. An investor who had paid over £12 would see the value of their investment almost double. By contrast, an investor who had bought at that recent price of under £6 would have seen their investment more than quadruple.
There is no guarantee of what the WPP share price might do in future, but this example does illustrate the simple point of how paying less for a share can lead to more capital gain compared to paying more.
A second reason why stock market turbulence could help an investor grow their wealth faster is yield. Right now, the dividend yield on WPP shares is around 6.8%. But an investor buying as recently as last December would only be earning a yield of 5.1% because of the higher share price at that time.
Building a bargain portfolio
Compounding a portfolio at 5.1% annually, its value could double in 14 years. Compounding it at 6.8% annually, by contrast, would take just 11 years.
The difference in yield when buying shares in a stock market crash versus beforehand can be even greater than that.
Bear in mind too that that compounding relates to the dividend only. The sort of capital gain I discussed above could help bring things forward even more.
But are things really that simple?
Of course, nothing is ever guaranteed in the stock market. Sometimes a share crashes during market turbulence because its commercial prospects have worsened significantly. Multiple large companies reduced their dividend following the 2020 stock market crash — including WPP.
So, careful share selection as well as diversification is important.
Has WPP’s share price fallen lately because of risks like AI reducing the need for creative agencies and a weak economy hurting advertising demand? Maybe.
But the business has a proven model and I expect advertising agencies will stick around in one form or another. AI could even help them, by reducing staffing costs.
With well-known agencies under its umbrella, cost-cutting benefits showing through and for now at least fairly strong advertising demand, WPP looks like a potential stock market bargain to me. I have recently added it to my portfolio.
