With the stock market steadily recovering from the 2022 correction, many investors are looking for the best shares to buy. And those who have been patiently waiting for the volatility to subside may be sitting on a nice lump sum of cash.
However, just because analyst forecasts have started to look more optimistic doesn't mean we're out of the woods yet. There are still plenty of economic challenges to overcome. And therefore, blindly investing £1,000 in beaten-down stocks to capitalise on recovery tailwinds isn't likely a prudent strategy.
During any period of stock market volatility, some of the best shares to buy are often the ones which have been hit the hardest. Over-emotional investors focusing solely on short-term disruption usually make bad decisions without considering the long-term potential.
However, in some cases, a mass sell-off may be warranted. Investors need to spend time thoroughly investigating why a stock has tumbled. A short-term disruption to the supply chain is less concerning than a fundamental problem in the underlying business model.
Sometimes weaknesses in a company aren't immediately obvious when reading through financial statements and trading updates. Therefore, deliberately seeking out the opinions of other investors who are bearish on a business is essential. Apart from avoiding falling into the pitfall of confirmation bias, this endeavour may reveal unknown undesirable traits that can fundamentally change an investment thesis.
In most cases, top-notch buying opportunities reside in sectors of the stock market that have fallen out of favour with investors. The lack of interest or boycotting of an industry often results in a significant price-value mismatch. And for those that can spot these bargain opportunities, a lot of wealth can be unlocked in the long run.
Today, the financials, technology, real estate, and consumer discretionary sectors seem to fall squarely under this category. While better opportunities may reside elsewhere, these industries could be an excellent place to start searching.
However, even the most meticulous researcher can end up overlooking things. Not to mention that businesses are ever-changing entities prone to disruption from both internal and external sources. As such, even if an investor successfully identifies one of the best shares to buy now, there's no guarantee it will deliver market-beating, or even positive returns.
That's why diversification is critical when investing lump sums. By spreading capital across multiple businesses in different uncorrelated industries, the impact of one failing is mitigated by the others.
Therefore, instead of investing £1,000 into a single business, investors should consider splitting their investment across two, or potentially three enterprises. Obviously, three stocks are insufficient to build a diversified portfolio. But it can be the start of one. And when more capital becomes available, investing in other high-quality enterprises can gradually reduce an investor's risk profile without compromising potential returns.
The post How to invest a £1,000 lump sum in the best shares to buy now appeared first on The Motley Fool UK.
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