Five tips for investing in a heated share market

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Psychologically, Bull markets can create their own problems for new investors, mainly when businesses have been on a price tear for some time. Investors fear they will have an accident as they try to merge into the oncoming traffic. Growth stocks, in particular have had a strong run, as investors continue to be on the lookout for the quality emerging leaders and disrupters of tomorrow.

But this growth cycle has seen many companies trading on forward Price-Earnings ratios that currently resemble inflated balloons, and many investors are rightly starting to recognise the increasing risks of taking a full position in such companies. With many presently priced for perfection, it won’t take much for a market darling to turn sour leaving new investors out of pocket.

What is the cost of staying out of a great business? In the last few years that cost would have been significant, and if the market continues running with this cycle, then the stocks that are seemingly over-priced will only become more expensive leaving investors holding the can of missed opportunities. After all, isn’t jumping into stocks hitting all-time highs better than trying to catch a falling dagger with price declining sharply?

When is it safe for investors to take the plunge and dive into a hot stock that has just come into your ‘investment potential’ radar? Should there be an opportunity you want to seize, here are five key tips for investing in a market that is close to the top of the cycle.

Looking in the rear-view mirror is not an investment strategy.

Far too many investors use the past as an indicator of the future direction of the share price, rather than focusing on the quality of the company and its prospects moving forward. Irrespective of where the current price has come from, investors have a decision to allocate their capital today. So, the only question that matters is whether “An allocation in this stock today represents the best chance to maximise my returns in the future?”

Have a clearly defined investment strategy.

In our view, it is the only way to stay focused on the future opportunity whilst keeping emotions at bay. If a stock meets your rules then include it, and when it doesn’t, sell it. By taking the buy and sell decision out of your hands (and head) you have clear rules to follow and act on. This same strategy defines our Star Stock selection process which applies a quantitative approach to stock selection.

Have a good spread of stocks to help absorb a shock.

If you equally weight your investments into say 20 stocks, then the importance of the performance of one stock is reduced as it only accounts for 5% of the overall portfolio. This will ultimately help deal with an occasional 20% pullback in one stock, which only actually represents a 1% decline in the overall portfolio. This buffer will go some way to mitigating the ‘importance’ of making the decision. Whereas in a concentrated portfolio a 20% fall in a single stock could have a significant impact.

Drip feed your investment to avoid buying at the wrong time.

Known as “Averaging in’’, this involves a process of buying smaller parcels of a stock at periodic intervals until you gain your desired full exposure. This is a useful strategy as it spreads the buying process making the timing of the purchase less relevant. While you might buy the first tranche for a price lower than the second or third parcel, it protects you from the future unknown where Murphy’s Law and volatility often see a price fall after we buy a stock.

You need cash to seize opportunities.

In these types of markets, it is not unusual for growth stocks to experience price pull-backs. Should you have the cash to do so, these can prove to be great opportunities to buy into great businesses at lower prices. Therefore, in markets where gains have been strong, it is prudent to take profits off the table, to build a cash war chest without allocating extra capital, ready to pounce when needed.

In conclusion, while risks are always elevated merging into a Bull Market, it doesn’t mean you have to miss out on the fun, provided you have a strategy in place to manage such times. While it may be prudent to not be too aggressive right now, “Investors’ lament” can be avoided, provided you treat any potential investment with respect and approach it within a structure that avoids road rage.

Five tips for merging your investment into a Bull Market

  1. Looking in the rear-view mirror is not an investment strategy.
  2. Have a clearly defined investment strategy.
  3. Have a good spread of stocks to help absorb a shock.
  4. Drip feed your investment to avoid buying at the wrong time.
  5. You need cash to seize opportunities.
Published 2 October 2018 | Financial Review

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