Beware! Bull markets can be injurious to your wealth

Alcohol gives us liquid courage, a magic potion that makes you feel invincible, that makes us think we can do no wrong. The bull market is not very different; it's a party that turns everyone into a genius, every stone into the next big thing.

The following excerpt from Peter Lynch's famous book 'One Up on Wall Street' captures the arrogance of bull markets brilliantly:

Stage 1
"In the first stage of an upward market - one that has been down a while and that nobody expects to rise again - people aren't talking about stocks. In fact, if they lumber up to ask me what I do for a living, and I answer, "I manage an equity mutual fund," they nod politely and wander away. If they don't wander away, then they quickly change the subject to the Celtics game, the upcoming elections, or the weather. Soon, they are talking to a nearby dentist about plaque.

When ten people would rather talk to a dentist about plaque than to the manager of an equity mutual fund about stocks, it's likely that the market is about to turn up."

Stage 2
"In stage two, after I've confessed what I do for a living, the new acquaintances linger a bit longer - perhaps long enough to tell me how risky the stock market is - before they move over to talk to the dentist. The cocktail party talk is still more about plaque than about stocks. The market's up 15 per cent from stage one, but few are paying attention."

Stage 3
"In stage three, with the market up 30 per cent from stage one, a crowd of interested parties ignore the dentist and circles around me all evening. A succession of enthusiastic individuals takes me aside to ask what stocks they should buy. Even the dentist is asking me what stocks he should buy. Everybody at the party has put money into one issue or another, and they're all discussing what's happened."

Stage 4
In stage four, once again, they're crowded around me - but this time, it's to tell me what stocks I should buy. Even the dentist has three or four tips, and in the next few days I look up his recommendations in the newspaper and they've all gone up. When the neighbours tell me what to buy and then I wish I had taken their advice, it's a sure sign that the market has reached a top and is due for a tumble."

That's right, the bull market is that cocktail party that actually gives stock tips to Peter Lynch. The Peter Lynch. He of the Magellan Fund fame, he who helped investors' money achieve an annualised return of 29.2 per cent in his 13 years of management. Imagine giving tips to him?

But that's what a bull market does to investors. A bet or two gone right during this phase makes them feel like Peter Lynch's long-lost twin. It makes them drunk on power - not very different from how drinking alcohol makes us overestimate our driving skills.

But here's a sombre reality check: over 3,300 drunken drivers lost their lives in 2021 alone, as per the Ministry of Road Transport and Highways. Similarly, most bull market parties are followed by the bear market funerals, and only when the bears show up and our investments crash do we learn that there's a fine line between genius and insanity.

Moral of the story
Overconfidence can be fatal, both for your health and wealth.

So, even if bull market parties can pump in a high sense of self, we strongly suggest you invest at least 80-85% per cent of your money in mutual funds and allocate only a small portion initially to test your stock picking skills. This is especially true for investors who have yet to experience a full market cycle, a period that usually lasts five to seven years.