6 traps to avoid in a bull market
The recent rally in the stock markets has everyone thinking we are in a bull market. It is often presumed that making money in a bull market is easy. And while there are several success stories, there are plenty of failures as well.
Unfortunately, there is no formula for sure-shot success in the stock markets. But there are some common mistakes investors can avoid.
Here are some mistakes investors must avoid while investing in a bull market to better their chances:
1. ‘The markets are so high. It’s best to book profits now.’ - Premature exits
Not selling in a bull market is as bad as selling prematurely. Investors often forget that stock market investments are long-term play. Therefore, booking profits prematurely is another mistake they must avoid.
It doesn't matter whether they are at the beginning of a bull run or towards the tail end because there is no way of knowing. No one can, as trying to time the markets is a futile exercise. “We wish we had perfect market timing (as well as the ability to fly). The reality is that no one does or ever will.’’ - Seth Klarman
Hence, falling or rising markets must not influence anyone’s decision to buy or sell a stock. It should only be a function of the stock’s future value.
2. ‘I'm sure the markets will continue to rise’ - Trying to time the markets
I often hear people say - I bet this trend will continue, we are in a Bull market now. So any stock you invest in will generate strong returns. Just to be proven wrong a few months later.
What investors fail to realise is that this statement implies that they have achieved the unattainable: rightfully timing the markets. Which, truth be told is impossible as no one has correctly and consistently predicted stock markets movements.
“After nearly 50 years in this business, I do not know of anybody who has [timed the market] successfully. I don't even know of anybody who knows anybody who has done it.’’ - Jack Bogle
'In my experience, most people who are lucky enough to sell something before it goes down get so busy patting themselves on the back they forget to buy it back.’ - Howard Marks.
I can quote many more successful investors on this. But that would be a waste of words as the verdict is pretty much one-sided on this, that timing the markets is futile.
Investors must remember that crashes come out of nowhere, making stock market movements hard to predict. It happened in 2008 and now again in 2020. So a wager on things staying the same for too long can only set them up for disappointment in case the markets turn turbulent or move sharply in the opposite direction.
3. ‘If a stock is trading at a PE of 70 then a PE of 50 is also justifiable.’ - Justifying overvalued investments and ignoring fundamentals
Positive sentiments in the stock marketplace can make a fundamentally weak, over-leveraged company look like the next multi-bagger.
As the stock markets rise, investors hunt for a bargain. They are desperately on the lookout for stocks which have fallen, trading at discounted valuations. Comparing them with the titans of the industry, they try to justify their inferior purchases. It has happened many times in the past. During the tech boom investors compared smaller subpar tech companies to Infosys. Throwing all logic out of the window, they assigned those companies higher valuations only to regret later.
Investors must beware of bull markets. As bargain hunting can lure them into buying massive underperformers with weak fundamentals. Avoid judging a company based on valuations alone and focus on the quality of business and management. The key is to follow Mr Buffet and Mr Munger advice: 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.'
4. ‘Who needs mutual funds? I can generate higher returns than my mutual fund manager’
Bull markets often give birth to several self-proclaimed geniuses.
Market optimism based entirely on notional profits tends to misguide investors. They start considering themselves great stock pickers who can outperform fund managers. And as a result of this blind confidence, they end up buying all sorts of random companies, forgoing fundamental in-depth research.
Novice investors forget that outperforming the stock markets repeatedly is a difficult task. But seasoned investors, who have experienced multiple market cycles understand that. Even when it comes to Fund managers, with all the information and a large pool of experience, only a handful of them manages to beat the market at all times. So to assume that a retail investor with limited expertise and research can achieve that will be wrongful.
5. ‘My FDs returns are nowhere close to my stock market investments. Maybe I should allocate more to equities.’ - Allowing market scenario to reflect one's portfolio allocation
It is one of the most common and expensive mistakes investors make in a bull market. As quick and lofty returns can fuel an investors’ greed to a level where they are willing to compromise on their asset allocation. Asset allocation is the process of choosing the right asset mix of bonds, equities or gold that reflects the investor's financial goals. Its primary objective is to lower investment risk by reducing over-reliance on a single asset class.
A bull run can lure some of the most seasoned investors into forgetting this golden rule of investing. They ignore their financial goals and willingly increase their allocation to the riskier asset class, equities, assuming the probability of a loss is low.
What they overlook is that equities are an extremely volatile asset class, capable of generating strong returns only over the long-term. And while bonds and fixed deposits might seem like laggards in a stock bull cycle, they play an important role as the stabiliser of returns.
Investors must remember that short-term returns in any asset class do not define their asset mix. Only their financial goals and the risk appetite thereof do.
6. ‘My friend made a killing in the stock markets. Maybe it's time I buy more.’ Following herd mentality
Another common mistake made by investors.
As mentioned before, self-proclaimed geniuses are a by-product of every bull run. Having made some money in a bull market, everyone is bragging about their stellar returns, tempting investors into buying to play catch-up. But, in this case, try to live with this feeling of FOMO, as the Millenials would call it. It is far better than making costly irreversible mistakes investors will soon come to regret. 'What the wise do in the beginning, fools do in the end'. - Warren Buffett.
Being a novice investor, I can honestly admit to making most of these mistakes. But everyone doesn’t have to. Much like a dwarf sitting on a giant’s shoulder, I chose to learn from learned thinkers and geniuses and learnt the critical components to succeed in the investment world.
I quickly realised how our emotions and our temperament affects our investments. And to succeed we have to simply cut through all the noise around us and focus on the investing fundamentals.
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