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The Coming Investment Trend You Should Avoid

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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.

For more insider investing and personal financial planning tips, check out the Fool's Rule Your Retirement service, which provides top-notch retirement and mutual fund advice. You can start your free 30-day trial today.

Amanda Kish is the Fool's resident fund advisor for the Rule Your Retirement investment newsletter. Motley Fool Options has recommended buying calls on Johnson & Johnson, which is a Motley Fool Income Investor selection. The Fool owns shares of Vanguard Total Bond Market ETF and has a disclosure policy.

Read/Post Comments (7) | Recommend This Article (16)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 14, 2010, at 1:14 PM, pondee619 wrote:

    Does the fact that it is easier to purchase individual stocks than it is to buy individual bonds make a difference in your stats? The easiest way to buy bonds is through a fund. It is far easier for an individual to buy individual stocks. Are stocks really being foresaken for bonds or are stock funds being shunned? Has the individual moved beyond stock funds and into specific issues and isn't quite there yet regarding bonds?

  • Report this Comment On April 14, 2010, at 1:14 PM, pondee619 wrote:

  • Report this Comment On April 14, 2010, at 3:12 PM, ActiveTraderX wrote:

    Stocks are a bubble. Bonds are a bubble too. Individual investors have jumped into the fire from the frying pan:

    Cash and short term treasuries is the place to be. US dollar is going to have a short term pull back. You can trade around that and get back into USD in a month or two. Euro will suffer more due to PIIGS. Australian dollar looks good for the short term.

  • Report this Comment On April 14, 2010, at 5:10 PM, bda123 wrote:

    I couldn't agree more with ActiveTradeX. Stocks are overvalued as are bonds. The real estate market is still devaluing quickly and will probably take two years to turn. Commercial real estate is looking worse. It will take a long time for the foreclosures to wash off the balance sheets of banks, pension funds, insurance companies, GE, and FNMA/Freddie. More banks will fail this year than last. There are still a lot of losses yet to be seen. This will cause a moderate short term level of deflation. At the end of it all the stock market will be lower and bonds will be about the same. Then you will see a significant move toward inflation and the bond market will tank. Avoid gold, it is hardly the best investment. Go for cash now, oil in the near future, and undervalued positive cash flow real estate in a couple years.

  • Report this Comment On April 14, 2010, at 5:22 PM, bda123 wrote:

    Note - the stock market went up lately because JPMChase had great profits. Take a look at the detail. It is all based on doing work in the bond market. Throw in some significant commercial real estate lose and inflation and you have a recipe for another tanking of the value of financials. That will cause the foreign bond buyer to reconsider even commercial debt issuance and you have a really tough future ahead. I hope I am wrong, but I haven't been yet.

  • Report this Comment On April 15, 2010, at 8:17 AM, tomd728 wrote:

    Any time there is so much attention and investment within the Markets to a relatively new phenomena

    derivitives come out of the woodwork.

    In the rush to score institutions scramble and throw

    product out there.

    What I have not heard is the "why" on the bond and

    bond funds enormous attraction these days.

    Some simple actuarial research over-laid on very recent history tells all one needs to know.

    1.Investors in their late 50s into their 60s and beyond are the lion's share of "money in".

    2.CDs pay next to 0.

    3.This group has seen Market gyrations seriously reduce their value at least three times in the last twenty years.

    Now there is simply no tolerance for a broad Market decline as their income is down and life expectancy


    They need to know, with some relative comfort, that the nest egg is guarded.Buy & Hold more.

    Me ? I have learned to navigate this leg of the Bull Market but of what I have only 35 % is in Stock and the balance in Bonds.It has served me well but I am

    quick to the re-balance bench if I smell a problem.

    This application worked in '09 and continued into '10.

    When I feel "never again" I go with it and never look back.


  • Report this Comment On April 15, 2010, at 1:58 PM, sept2749 wrote:

    I am 60 and less then a year from retirement. I don't like funds so I buy individual municipal bonds that are 3x tax free and highly rated ( as much as you trust AA-AAA). This gives me upwards of 4.5% tax free. Ok for now. I also buy top blue chips that pay solid dividends. I know I should be buying some small caps for growth but I fear the loss of money. I look to stock advisor and income investor for ideas but I have to understand the basic business model and feel comfortable with it. I got lucky and picked up some real good stocks at great prices last year. Good article!

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