A stock market rally may seem like an unlikely scenario at the moment, given the current economic environment. After all, inflation is near record highs, a cost-of-living crisis has sent consumer spending down the toilet, and rising interest rates are making everyone’s debt more expensive.
Needless to say, that doesn’t exactly paint a pretty picture.
Yet the track record of flagship indexes, like the FTSE 100, show that buying terrific stocks during times of crisis can be a highly lucrative decision. Why? Because some of the best years of stock market performance have followed directly after some of the worst. And this ongoing correction certainly seems like it falls into the latter category.
Does this mean a rally is guaranteed to happen in 2023? No. But history would certainly suggest it’s possible, providing the economic situation doesn’t worsen. And since inflation is slowly moving back in the right direction, I’m optimistic about the future.
So, with that in mind, how should investors use their Stocks and Shares ISA to invest £20k in 2023?
Buying cheap shares before a stock market rally
The return of positive momentum to the markets is great news for all businesses. But it’s the companies whose share prices have been beaten down that have potentially the most to gain.
There are undoubtedly plenty of stocks that have been sold off for good reasons. After all, firms that have overly relied on debt financing could be in quite a pickle, thanks to interest rate hikes. In fact, this is precisely how Cineworld ended up in its current near-bankruptcy situation.
But not all seemingly collapsing stocks are doomed to fail. Many are just facing short-term headwinds, while others have been caught in the panic-selling crossfire. As such, the downward share price movement has actually created buying opportunities for patient investors. And their patience could be generously rewarded when the stock market rally eventually turns up.
Nothing is risk-free
If a share price recovery emerges in 2023, buying high-quality stocks today is most likely a sensible investment decision. But as previously mentioned, there’s no guarantee this will happen. In fact, valuations may continue to tumble next year as they have done in 2022.
So, the question now becomes, how can investors capitalise on the eventual stock market rally while keeping risk in check?
This is where pound-cost averaging steps in. Instead of investing £20k with an ISA all in one go, the capital can be slowly drip-fed into investments over several months. That way, if share prices continue to drop, investors can buy more at an even better price, bringing the average cost per share down.
Furthermore, it’s important to remember the critical role of diversification.
A terrific business today may not be so terrific in a couple of months’ time. Even the most well-researched investment thesis can still be derailed by an unpredictable external factor. So, by owning a basket of high-quality enterprises, the negative impact of one failure can be offset by the success of the others.