Bull Market Guide: The Different Phases And How To Invest During One

You've seen the headlines: Investing pundits say a new bull market is here. Read on to learn what a bull market is and how you can safely maximize your returns when stocks are on the rise.

What Is A Bull Market?

A bull market is a sustained period of rising stock prices. The accepted bull market definition is growth of 20% or more above recent lows, as measured by the S&P 500 or another major stock index. Many experts add the qualification that the index must also achieve new historic highs.

Characteristics And Significance Of A Bull Market

Bull markets go hand-in-hand with investor confidence and positive market sentiment. You'll see this reflected in investor sentiment metrics like the Fear and Greed Index or the VIX.

Often, the positive sentiment is driven by economic expansion. When investors see economic conditions improving, they expect those improvements to usher in higher business profits. That promotes more trading and rising stock values, as investors position themselves to gain from stronger earnings going forward.

Those rising stock values can affect your net worth directly and quantifiably.

Timing: Bear Vs. Bull Market

Even better, bull markets tend to last longer than bear markets—which means the gains keep coming. Bull markets typically stretch out for two to five years, delivering an average S&P 500 gain of nearly 178%. Bear markets, on the other hand, usually wind down within a year.

History's longest bull market, following the Great Recession, hung around for nearly 11 years. During that time, the S&P 500 grew from 734.52 in February 2009 to 3,337.77 in January 2020. That's a total increase of about 354%, which averages to 32% annually. This unusually prosperous era in the financial markets made millionaires, recruited new investors and encouraged the development of user-friendly apps and tools to democratize investing.

Strategies For Investing In A Bull Market

If we are in the early stages of a new bull market, now's the time to prepare. You want your share of the gains, after all. Follow the four strategies below to capitalize on rising stock prices.

1. Diversification And Asset Allocation

You won't profit from a bull market unless you're invested in stocks. So, check your asset allocation. It could be time to raise your exposure to equities and decrease your exposure to bonds and cash.

Proceed with caution, however. Market conditions can change quickly, and a true bull market may be slower to materialize than you expect. Don't assume stocks are only going up from here. And, a standard investing rule: don't invest cash you may need in the next five years.

Instead, look to hold a good mix of stocks, bonds and cash. If you're not sure what that mix should be, try the Rule of 110 for an age-based allocation. Simply subtract your age from 110 and invest that percentage of your portfolio in stocks. If you're 40, your allocation would be 70% stocks and 30% bonds and cash. This composition prepares you for a broader range of scenarios vs. going all-in on stocks.

If you do increase your stock exposure, add equities from multiple industries. Industry diversification protects you from sector-specific weakness and gives you access to sector-specific strength.

2. Focus On Growth Stocks And Sectors

Growth stocks and sectors appreciate faster than peers and the overall market. Many, but not all, growth stocks are young, innovative companies that are using technology to create efficiencies or solve global issues (such as nonrenewable energy dependence).

Researcher IBISWorld identifies CBD (cannabidiol, the active ingredient in cannabis, which does not cause a high) product manufacturing, 3D printing and solar power as three of the fastest-growing U.S. industries in 2023. Artificial intelligence is another area that could grow quickly—since the application of AI technologies can benefit many industries, from manufacturing to healthcare.

Growth stocks tend to perform well in bull markets, but they can be riskier than more stable, established companies.

3. Consider Value Investing

Value stocks are equities that appear to be underpriced—meaning they are trading for less than their intrinsic value. This can happen when investors overreact to bad news or when the investing climate favors faster-growing assets.

Optimistic bull-market investors do prefer faster-growing assets. So value stocks may lag when the market is especially strong.

For the patient, long-term investor, this can be a buying opportunity. Value stocks usually show their worth in bear markets. Many of them also pay dividends. So you can use a bull market to increase your value stock holdings efficiently—as preparation for the next bear market. In the meantime, you'll collect dividends while you wait for these stocks to shine.

4. Dollar-Cost Averaging

Dollar-cost averaging or DCA is the practice of investing on a set schedule and budget. An example would be investing $400 on the same day every month versus attempting to time your purchases strategically.

In the early days, bull markets can be volatile. DCA is a strategy for managing that volatility—essentially by ignoring it. You simply invest on a schedule no matter if the market's up or down. When the market's down, your budget buys more shares, which lowers your average cost basis. When the market's up, your budget buys less shares. But you probably don't care because the rest of your portfolio is worth more, too.

Risks To Be Aware Of In A Bull Market

Bull markets can deliver easy gains, but there are some pitfalls to avoid. Three big ones are overconfident investing, the risk of getting caught in a market bubble and the possibility that interest rates and/or inflation could dampen investor spirits.

1. Overconfidence And Speculation

It's human nature to relax your investing approach when stocks keep rising. Worse, a true bull market can reward you for taking on more risk—at first. The problem shows up when the bull market ends, which always happens eventually.

If you are holding a bunch of speculative stocks and the market goes south, you'll see outsized losses. Some of those losses may be temporary, but a downturn could also permanently change the outlook for smaller, less established companies.

2. The Danger Of A Market Bubble

You can control your own investing approach, but you can't control everyone else's. Less disciplined or more aggressive investors will undoubtedly dabble in more speculation during a bull market. If that trend takes over the investment community at large, it can create a market bubble. That's when stocks broadly are trading for more than they're worth.

Market bubbles aren't all bad. They do create opportunities to gain as stock prices rise quickly. The downside is that investors will inevitably recognize the bubble and change course. That can lead to investor panic, which will cause stock prices to fall quickly. The correction or crash that results likely ushers in a new bear market, which will linger until investor confidence is restored.

3. The Impact Of Interest Rates And Inflation

The last few years have brought a strange set of economic and financial market circumstances. We have lingering high inflation and interest rates, a heavily predicted economic recession that still hasn't appeared and, more recently, a surprisingly strong stock market.

How those factors play out over the next 12 or 18 months is anybody's guess. The Fed may continue to raise interest rates. Or inflation may spike again. Either outcome could delay, dampen or reverse a bull market.

Tips For Success In A Bull Market

Now, let's talk about how you can mitigate those bull market risks. Four strategies to consider are staying disciplined with your investing approach, keeping a long-term focus, rebalancing regularly and, if needed, retaining a financial advisor.

1. Stay Disciplined

Ongoing discipline with your investing approach helps you avoid slipping into an overly aggressive or speculative strategy. You can position yourself to remain disciplined by documenting your investing parameters and process. Then, commit to your approach.

You can make exceptions but evaluate them carefully. Consider why you want to step outside your documented approach. Also think through how the prospective stock might behave in a weaker market. And, make sure you have a defined exit plan for your more speculative assets.

2. Think Long Term

Having a long-term timeline insulates you from a reversal in market dynamics. Say a bubble brews next year. If a crash follows, you will appreciate having the option to wait out another bear market. Give yourself that luxury by holding enough cash so you won’t need to tap your investment account for emergencies or major purchases.

3. Rebalance Regularly

The equities portion of your portfolio will appreciate quickly in a bull market. Over time, you'll end up with more exposure to stocks than you want.

As an example, say you're targeting an asset allocation of 70% equities and 30% bonds and cash. In a bull market, stocks could realistically appreciate 30% in a single year. If that happens and your bonds hold steady, your allocation will shift to 75% stocks and 25% bonds and cash.

Periodic rebalancing restores your targeted 70/30 allocation. You'd simply liquidate some of your stocks and use the proceeds to buy bonds. This is a great time to realize some of your bull market profits.

4. Consider Working With A Financial Advisor

If you're not sure what your investment approach is or should be, ask for help. A financial advisor can guide you from bull market to bear market and back, based on your timeline, risk tolerance and financial goals.

Catherine Brock, Contributor