By most accounts we are presently in - or set to enter - a new bull market as the economy is showing some definite signs of recovery. Here are some common mistakes investors can make in a bull market, and how to best avoid them. (Need a refresher? Learn these crucial barnyard terms by reading Stock Basics: The Bulls, The Bears And The Farm.)
Mistake #1 - Getting "all in" too soon
All long-term investors get excited when the stock market turns positive again, especially after suffering through a recession as long as the one we've seen. But if you've been out of stocks and have cash sitting on the sideline, take the "patient but diligent" approach. Don't feel like you have to put all your money in at once.
Spreading your re-investment out over several weeks or even months accomplishes two important things. First, you'll get to see how the market is behaving and adapt your strategy along the way. Secondly, you'll avoid magnifying a timing mistake. If the market were to dip south the day after you invest, you'd suffer either regret or discomfort in terms of the choice you made. You might even be tempted to move your money back out suddenly, which only incurs extra trading costs.
True bull markets last a long time, so be willing to sacrifice a few dollars in exchange for peace of mind and extra adaptability. (Learn how to make gains even if you don't get in at the right time. Read Trading Is Timing.)
Mistake #2 - Not being diversified
This mistake can be easy to make; you read a newspaper and see a hot mutual fund or ETF, then decide to invest a large portion of your portfolio in hopes of chasing that big return. The problem here is that most of the "top performer" funds tend to be focused on particular industries or sectors, as certain areas of the market can do very well for short periods of time.
In a true bull market, all sectors should see growth. The way it often works is that certain industries rise first, like financials or industrials. Then mid-bull, other industries step up and become the "top performers." Don't try to time these moves; just position yourself broadly in a well-diversified mutual fund, index fund or ETF. (Learn how to pick the best of the bunch. Check out Five Ways To Find A Winning ETF.)
There are dozens of S&P 500 proxies out there that give you broad access to the biggest companies in the world, and funds like these should form the backbone of your investment policy.
Mistake #3 - Avoiding international markets
One of the valuable lessons we all learned in this last bear market is that the world's economies all need each other to grow. The U.S. led us into the recession, but the whole world fell with us because our fates are still quite linked. Most emerging economies need the U.S. and Europe's consumers to sell their goods to. And in a full-blown bear market, these emerging economies - like China, Brazil and India - may actually see their stock markets rise more than the older, more developed Western economies.
If you feel solid about the U.S. economy, don't be afraid to take a modest portion of your portfolio (the 20% range is a good one) and invest it internationally. You could get a good boost to your returns while also spreading out your risk.
Mistake #4 - Not revisiting your asset allocation
Are stocks the right place for you to be? If so, how much of your nest egg should you allocate to stocks versus bonds and other investments? These are crucial questions to ask, especially when the market changes direction. Many investors can benefit from seeking professional counsel from a CPA or CFP on this matter, but there are basic tenets that can be outlined here.
Are you nearing retirement, a home purchase or sending a child off to college? There are times when the potentially higher returns of the stock market just aren't worth the risk. Know when investing in bonds or sitting in cash is your best option. (Overwhelmed by investment options? Learn how to create an asset allocation strategy that works for you. Read Five Things To Know About Asset Allocation.)
If you're a younger investor building towards future goals, then stocks are probably the best choice for you, but take a few precious hours to revisit your overall plan. Then you can invest in the stock market with confidence, and enable yourself to take the inevitable up and down movement of the markets in stride.
Mistake #5 - Not Doing Your Homework
When stock markets are heading upward and onward, it can be all too easy to sit back and rest on our laurels. If you invest in individual stocks, or have been doing your own homework for years, a bull market is not your ticket to quitting the process.
Yes, all of your investments may be doing splendidly, but you still need to keep up with earnings reports and other news. You need to make sure that the companies you've banked on have positioned themselves to grow profits in the future. Are there new competitors creeping up to threaten your favorite company? Are they investing in a new project that may not pan out for several years?
It would be a shame to miss out on the meatiest part of a bull market by investing in the wrong companies, so if you're a DIY-er, keep up with your research. It just may be your ticket to finding a big winner - or to avoiding a land mine! (Learn how this key metric is calculated and how it is used to judge market performance. Check out Earnings Forecasts: A Primer.)
The Bottom Line
Bull markets are certainly welcome events, but they are not a panacea. Avoiding these five mistakes will put you in the best position to profit without passing up opportunity or overextending yourself.