The idea of buying cheap shares may seem less appealing after the stock market crash. It highlighted the volatility that can be present in the stock market over short time periods. It also showed that paper losses that can be incurred by any investor.
However, over the long run, purchasing undervalued companies could be a profitable move. It’s a strategy that’s been used to great effect by Warren Buffett. The billionaire investor 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’s 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.
Buffett has consistently purchased cheap shares after bear markets. This has enabled him to buy high-quality businesses at low prices. Over time, they’re 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 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’s imperative that investors follow 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. But 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’s 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 experienced so far this year.
Moreover, improving investor sentiment towards risky assets such as shares may reduce demand for defensive assets such as gold. This may negatively impact on its performance.
Meanwhile, Bitcoin’s lack of infrastructure and regulatory risks mean 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 Buffett’s advice and buying a portfolio of stocks could be a more prudent means of improving your long-term financial outlook.
Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.