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If investors have mastered one skill over the years, it's the ability to be in exactly the wrong place at the wrong time. The average investor is very skilled in the art of chasing performance, diving headfirst into areas of the market that have been on a hot streak, while ignoring "boring" segments of the market that haven't outperformed. Unfortunately, such an approach is usually just a fast track to disappointment.
Following the crowd
Anyone who has been paying attention to investor trends lately knows that all the recent market action has focused on one area: bonds. Investors have reacted to the last market downturn by yanking money from stock funds and fleeing for the perceived safety of bond funds. Even after stuffing nearly $400 billion into bond funds in 2009, investors' preference for fixed-income instruments has continued unabated this year. According to Investment Company Institute, another $90 billion made its way into bond funds through the last part of March, while just $2.4 billion has flowed into domestic stock funds.
Even with the specter of higher interest rates on the horizon, investors can't get enough of bonds. And we all know that the Wall Street types can follow the money better than anyone else. That means we're likely to see a slew of new bond funds and new bond products being brought to market in the coming months. In fact, according to Morningstar data, 16 fixed-income funds have been launched this year, compared to 14 stock funds. That may not seem like a huge difference, but compare that to last year, when 179 new stock funds and only 72 bond funds were born.
Ignore the fad
I'm pretty confident that we'll see a whole slew of new bond products on the market in 2010, in response to overwhelming investor demand. However, this is one trend that investors can safely ignore, on both a small and a larger scale. First of all, existing bond funds and ETFs are more than sufficient to meet investor needs. The purpose of having an allocation to bonds is to reduce volatility and protect capital over the long-run. You can do that with a broad-market, low-cost exchange-traded fund like Vanguard Total Bond Market ETF (NYSE: BND ) or iShares Barclays Aggregate Bond Fund (NYSE: AGG ) .
There are scores of other funds that focus on various segments of the bond market if you need more specialized exposure. Odds are good that many of the funds that will hit the market in the near future will be more exotic fare, boasting investment strategies that investors don't really need at prices that investors really shouldn't pay.
More importantly, if you've been loading up on bonds out of fear that the market may take another tumble, be aware that you're feeding into the performance-chasing mentality that has tripped investors up in the past. The damage has already been done to the stock market, and the recovery period has begun. It's human nature to want to run for the hills when things are looking bleak. But by fleeing the stock market after the fall, all you've done is lock in your losses and taken yourself out of the game for any near-term future gains. The truth is that the bullish bond market cycle is at an end. If you want to get your portfolio back on track, stocks offer the greatest growth potential in the coming decade.
Stocking up on the best
All investors, even those with 30 or more years until retirement, should have at least some fixed-income exposure in their portfolio to help smooth out bumps in the market's road. But stocks should still make up the biggest part of your allocation for almost all investors. If you're anxious about dipping your toes back into the equity waters, consider picking up a low-cost, well-diversified ETF as a starting point. Some good choices include Vanguard Total Stock Market ETF (NYSE: VTI ) , iShares S&P 500 Index (NYSE: IVV ) , and the SPDR S&P 500 ETF (NYSE: SPY ) .
So far in this market rally, lower-quality stocks and higher-risk asset classes like emerging markets and small-cap stocks have taken center stage. However, don't count on that trend continuing for too much longer. Investors should still maintain their long-term exposure to small-caps and emerging stocks. Just don't be lured by hot returns and load up on these areas to make up lost ground. Domestic large-caps should still form the backbone of your portfolio. I'm guessing this corner of the market will shift back into a leadership position in the next stage of the market recovery, so make sure you've got adequate coverage here.
Likewise, dividend-paying stocks haven't exactly been an investor favorite as of late, but if economic growth proves elusive in the future, your portfolio will be glad for that extra shot of dividend income. Chevron (NYSE: CVX ) and Johnson & Johnson (NYSE: JNJ ) are both decent blue chips with reasonable valuations and yields in excess of 3%. It can't hurt to make sure you've got some strong dividend payers sprinkled among your large-cap holdings.
I'm betting that investors will eventually forget their fear of stocks and move slowly back into the market in the coming quarters. However, by letting their emotions get the better of them, they will have missed out on almost all of the immediate post-recession rebound. Bonds surely have a place in everyone's portfolio, but stocks will likely be the superstars of the next decade, so make sure you're not hiding on the sidelines while the market passes you by.
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