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3 things smart investors do in a bull market

The S&P/ASX 200 Index (Index: ^AXJO) (ASX: XJO) is currently trading above 5,500 points having gained around 12% in the past year and 44% in the past five years. While overall, the pricing of stocks may not be ringing alarm bells, by the same token it is also getting much harder to clearly identify value.

While I’m not predicting an imminent crash and nor is it generally in investors’ interests to spend their time attempting to time the market, I would suggest that it’s hard to see the market moving significantly higher in the short term based on fundamentals. Here are three things that smart investors are doing to cope with the lofty market levels.

1)      Holding cash. One way to protect your portfolio is to increase cash levels. Not only does this reduce the risk of capital loss but it also provides firepower to acquire stocks in any subsequent sell-off. A review of WAM Capital Limited (ASX: WAM) shows that this listed investment company (LIC) currently holds approximately 40% of its portfolio in cash.

 

2)      Play defence. Should the market struggle to make further gains or fall then owning defensive stocks can help. Such companies could include Transurban Group (ASX: TCL) and Sydney Airport Holdings Ltd (ASX: SYD). Note that simply owning blue-chip stocks such as Telstra Corporation Ltd (ASX: TLS) or CSL Limited (ASX: CSL) may not be the answer as this group can also experience overvaluation and be subject to significant falls.

 

3)      Focus on value. One of the best investment choices which smart investors make not only in a bull market, but in all markets is to buy undervalued stocks. Owning a portfolio of “cheap” stocks, selling them when they reach fair value and replacing them with new “cheap” stocks is a proven successful formula. Platinum Asset Management Limited (ASX: PTM) is an example of a fund manager who has practiced this technique successfully for decades.

As I said, owning undervalued stocks is one of the very best ways to protect your portfolio from a market fall which is why I recommend you consider adding our #1 ASX pick to your portfolio.

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Motley Fool contributor Tim McArthur does not own shares in any of the companies mentioned in this article.

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