Overemphasizing A Bull Market Could Mislead You

Although it can be exciting to talk about a bull market, you might want to temper that a little. This is the reason why: Investment returns are not guaranteed, even in the event that the market's overall value surges.

Consider the first half of 2023, when the S&P 500 index increased by 20% from the year prior. Twenty percent is a nice increase. One issue, though, is that the market fell to such lows in 2022 that this year's gains are merely offsetting last year's losses.

Put differently, a lot of investors are just being brought back to their break-even point by this bull market. Perhaps it isn't even bringing them back to a break-even point.

Furthermore, get into the details of a bull market. You can find that virtually all of the upward movement is being driven by a relatively small group of companies, in which case you might or might not be invested.

Let's examine a current illustration. The majority of the S&P 500's gains during the stock market's spring 2023 rally came from a narrow set of tech stocks. Not much was happening to the total values of your portfolio if the majority of your money was invested in other equities, as it should be in a well-diversified portfolio. It's possible that you were wondering why you weren't benefiting from the amazing market gains that you were reading and hearing about in the news, leaving you scratching your head.

This point was recently brought home when the Nasdaq 100, another index, was forced to do a "special rebalance" due to noncompliance with the fund diversification guideline set forth by the U.S. Securities and Exchange Commission. Five hundred and seven firms made up fifty-five percent of the index's weight. These included Tesla, Alphabet, Amazon.com, Apple, Microsoft, Nvidia, and Meta. It was feared that the small number of these enterprises was distorting the state of the market, and that balance was required to rectify that.

Imagine the impact on the Nasdaq index as a whole if just one or two of those companies had a bad quarter or year. An index's goal is to distribute risk among numerous companies, thus the SEC mandates changes when any one or more of those companies take up an excessive amount of the index's weight.

These instances demonstrate how bull markets can occasionally be deceptive. If you evenly weight the 500 equities that make up the S&P 500, they are up less than 4% year to date as of September 2023, when I am writing this. However, the S&P 500 as a whole is up 17%.

You are right if you are starting to suspect that you should be cautious about the emphasis that is put on a bull market. So what ought to you to do in its place?

Here are some recommendations:

Examine the larger market. There are other stock indexes to consider, but the S&P 500 is frequently the focus of attention. Every one has benefits of its own. You can obtain a more comprehensive and lucid image of the market as a whole by looking at them. A stock market index called the Russell 2000 index calculates the worth of 2,000 smaller businesses. A lot of exchange-traded funds and mutual funds are linked to or based on the Russell 2000.

The Wilshire 5000 is an additional stock index that covers nearly all U.S. publicly traded companies. For comparing returns, the Wilshire 5000 is perhaps the greatest benchmark because of this.

Examine the performance over a longer period of time. Avoid being obsessed with a stock's extraordinary performance since a specific date. Let's imagine that for the past seven months, the value of a stock has increased dramatically. That's great, but what would happen if you could go back eight months? maybe a year? or half a decade? What does the long-term performance look like?

With a longer time frame, you may get a clearer idea of how well the business and its stock have done in the past and determine whether the current situation is unusual.

Pay closer attention to preventing large losses. Large losses provide more harm than benefit. Is this the case? because one cannot make up a percentage loss by gaining the same percentage back. Assume you invest $10,000 and see a 25% loss this week. Your investment now stands at $7,500. However, the market rises the next week, and you make 25%. Have you returned your $10,000 initial investment? No, as $1,875, or 25% of $7,500, gets you $9,375. In actuality, you are down $625 even though you gained and lost 25%.

Imagine that the timing was now reversed, with the 25% gain occurring first. Your $10,000 investment would increase by $2,500 to $12,500. The 25% loss, however, would come at a cost of $3,125. You are now back to your $9,375 net amount. Large losses do indeed hurt more than large gains do when figuring up overall returns.

In particular, exercise caution if you are retired. If you are in retirement and taking money out of your investments to cover living expenses, those significant losses cause double damage. Losses compounded with withdrawals have the potential to quickly deplete a portfolio. For this reason, it's a good idea to review your portfolio as you get closer to retirement and think about lowering some of the risk.

This does not imply that you ought to give up hoping for a bull market. However, you should maintain perspective and bear in mind that bull markets, particularly those that are driven by a small percentage of the S&P 500, may be misrepresenting the performance of the market as a whole.

If you're going to chime in on the enthusiastic talk about the bull market, at least be honest about what you're pleased about.