If history is any guide, this bull market likely ends with investors becoming too euphoric about stocks’ prospects—not seeing that expectations of a shimmering financial future outpace a dimming economic reality. This doesn’t appear to be all that close today, but the time to prepare yourself to shun over-optimism isn’t when it actually arrives, it’s beforehand. Now, this doesn’t mean you should squirrel away investible cash waiting for the drop. It just means you shouldn’t chuck your disciplined investing strategy due to emotion—on the upside or down. Below are a few principles to help guide you as this bull market matures.
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1. Don’t chase heat. As euphoria sets in, investors often seek the hottest-returning stocks or sectors, assuming momentum will carry them sky-high. And they might stay hot! But they might not, and a selection process that weights past returns heavily breaks a cardinal investing rule: It assumes past performance predicts future return.
How a stock performs today has zero … ZERO … bearing on how it does tomorrow, in six months or a decade from now. Remember when energy stocks were hot in the late 70s? In 1979 and 1980, the S&P 500 Energy sector rose 68% and 83%, respectively. Folks got giddy! Then the oil bubble went poof, and Energy stocks fell three straight years. Then there is Tech in 2000, a story you’re probably all too familiar with—hot dot.coms turned into dot.bombs. Nothing lasts forever. Don’t let the feeling of missing out make you think differently—if your pals are boasting, they might well be in for a roasting.
2. Don’t be under-diversified. Another late-bull market mistake? Piling into one or a few stocks—or one country or sector. For some, the goal is to maximize returns. For others, it’s the comfort factor—invest in what you know, whether that’s the industry you worked in, the company you worked for, or a field you’re most interested in. Regardless of the motivation, these are all forms of under-diversification—a risky tactic.
The fewer stocks or sectors you own, the more your returns are tied to a very narrow set of drivers. This might seem great if your picks are flying high. But what if they aren’t? What if you’re in the one industry that goes down while the rest of the market goes up? What if you miss out on far better opportunities? Read More…