It is one of the hardest things for investors to do. What am I referring to? It’s this: Breaking away from the tendency, in making investment decisions, to be highly influenced by how things have been going lately, and then assuming such observations suggest that the same general type of results will carry forward for at least the next several years, if not indefinitely.

While it may often be true that investments that have been doing well lately will continue to do well over the relatively shorter term, investors, in my opinion, should be much more cautious when ETFs/ stock funds appear to be showing signs of moderate to gross overvaluation. Those happenstances may not occur that often: they most likely will occur mainly late in extended bull markets.

Investors mindfully, but perhaps just sub-consciously, have much greater tendency to invest more in stocks during a long bull market, and with greater confidence, than when stocks aren’t in one, and instead are either a) just chugging along moderately well but not some downside, b) essentially going nowhere over a considerable period, or c) are in, or near, a bear market.

For many, it seems hard to not to invest more during a prolonged bull market, and also not to invest in the prior best performing types of funds under what appear to be highly favorable conditions. People seem naturally inclined to extrapolate past to future. They tend to assume that what has been working well will continue to do so, which in the case of a bull market, is typically stocks in general. Additionally, they also tend to believe those specific categories of stocks which have been performing particularly well, and the best performing market sectors, will continue along the same path.

A Re-think Is Often Necessary

Under such circumstances, investors, rather than investing as they might have before the overvaluation began, need to think even more than otherwise, about what their returns might be as far as three years ahead, as opposed to, say, merely over the next six months, or even the next year or more.

Why? Here are some data showing what might otherwise happen:

About a year and a half ago (July 2014), stocks from around the developed world were on a tear. Prior one year returns were at least 20% pretty much no matter where one looked, and even more caution-inducing from my point of view, 5-year annualized returns were generally in the high teens, such as the S&P 500 index, up 18.8%. Virtually all stock fund categories were overvalued, as repeatedly emphasized over many months before that date in articles I authored on my website and elsewhere, including on Safe Haven.

Which types of stock funds were looking the strongest, and therefore, to the unwary, deemed most likely to continue their sizzling performance? Some sector fund returns were showing near 30% one-year returns or better, including health care, natural resources, and technology. Over the prior 5 years, small- and mid-caps, as well as health care and real estate sector funds were approximately averaging at least 20% annualized returns. So, it is not surprising that back then, aside from investing heavily in the broad market and international stocks, investors had also gravitated toward relatively large positions in small caps, mid caps, and the above sectors through funds and ETFs.