Many investors look back on the two most notorious market bubbles of the last 20 years—the tech bubble of the 1990s and the real estate bubble of the 2000s—and pledge not to get caught up in anything like that again.
They’ve acquired hard-earned confidence that they can now recognize mounting risk from irrational exuberance, the mentality that pushed prices of already overvalued tech stocks to ridiculous heights in the 1990s. Their portfolios got slammed when the tech sector crashed in 2000, bringing much of the market down with it. Many now recognize how they went wrong: by getting caught up in price escalation that defied reason.
A decade later, a huge real estate bubble prompted many to over-pay for homes and ushered in a financial crisis and the Great Recession when the air came out of it and overvalued investments based on it.
Market bubbles have been around since currency was invented. A classic example is the Dutch tulip bulb mania of the 17th century, when bulbs of a strikingly beautiful species of tulip became the object of speculation across Europe that drove their price up thousands of times—until it sold for six times the average person’s annual salary. As always, there was a lot of pain when this bubble popped and the bulbs once again sold for a sane price.
Centuries later, we see that human nature hasn’t changed. Now, world economies are investment-based, and stock market bubbles are a perennial risk because of herd thinking. But even when this mentality isn’t producing bubbles, it poses a risk for investors that can hurt their investment returns.
People toughened by losses from the tech stock crash or the real estate crisis may think they’re now immune to “bubblethink.” But many aren’t because they follow the investing herd like lemmings, mouse-like creatures in northern latitudes known for their unthinking allegiance to the herd. Lemmings follow each other so faithfully that they sometimes end up running into lakes and drowning en masse.
By investing with the herd, people exhibit bubble behavior on a lesser scale. When herd buying drives up the price of an investment, people buy it because that’s what other investors are doing. When that investment begins to sink and they see the herd selling, they sell, too—at a loss. Thus, by following the herd, they end up buying high and selling low.
Instead of following the herd, chasing flavor-of-the-month investments, it’s far better to chart your own course with a well-designed, goal-driven financial plan that includes a diversified global investment portfolio to manage risk. By holding the right amounts of different investments with values that often move in different directions at different times, you can protect your nest egg from sustaining too much damage when any single type of investment craters.
Then you’ll be investing wisely—unlike lemming investors, who blindly follow what everyone else is doing, often leading to their financial demise.
This content is based upon information believed to be accurate by ISI Financial Group, Inc. and is not intended to provide specific financial advice. Always seek professional guidance before making any financial or legal decisions.
