Believe it or not, the various investment bubbles we’ve seen form and burst in the last few decades – real estate and dot-coms in particular – have a lot to do with flowers. The first disastrous investment bubble occurred within the Dutch tulip bulb market in the 17th century and investors haven’t been the same since.
Just as we’ve seen in stocks, cryptocurrencies, and a variety of other investment vehicles in modern times, prices for tulip bulbs in Holland grew far too high for demand and suddenly collapsed, plummeting back down to earth while dragging many temporary fortunes along with them. This sounds familiar for good reason as the parallels between that tulip market and our modern investment landscape share many similarities.
Investing with Blinders
The root of most investment bubbles only becomes obvious in hindsight. In fact, most bubbles are rooted in such subtlety that the participating investors only see the telltale signs after the fact. While some of this can be attributed to shortsightedness in valuations, much of it can be sourced to human nature.
Like it or not, the prospects of rapid growth can cultivate a form of greed within the marketplace that is not intrinsically good or bad but, matter-of-factly, an inescapable facet of what it means to be human. Just as fear can create unwarranted selloffs in a volatile market, emotion has a way of putting blinders on portions of the investment community as the prospects of unparalleled growth obscure better judgment.
Dealing with the Inevitable Crash
As the euphoria of an investment bubble crests and profit takers start to cash out, emotions within the market quickly turn as greed makes way for fear and panic sellers cause the bottom to fallout. While some bubbles come and go without creating any long-term, systemic damage, others can set entire economies back decades. The market bubble and subsequent crash in Japan during the 1980s created economic stagnation that took well over a decade to dissipate.
Limit Your Exposure to Bubbles
Depending on how you invest, at least some exposure to bubbles might be unavoidable. For instance, if you use mutual funds as your primary investment vehicles, those funds will more than likely own positions that are subjected to a bubble. However, well-diversified investment instruments like most mutual funds will also afford a measure of protection simply by spreading the assets out over multiple classes and industries. Like any source of volatility, diversification in your portfolio can significantly reduce the impact an investment bubble might have on your invested assets.
Jeremy Wallace is founder and chief investment officer at Wallace Hart Capital Management, an independent financial services firm committed to offering comprehensive advice and customized services. Jeremy has 20 years of experience in the financial industry and is passionate about helping clients preserve and enhance their wealth so they can pursue their passions. Jeremy graduated from Emory University with a degree in international economics and a certificate in financial planning. Outside of the office, Jeremy spends most of his free time with his wife, Julie, and their three children, Isabel, Lincoln, and Reid. He is an avid Chicago Cubs baseball fan, and he enjoys golfing with his wife and traveling with his family. Learn more about Jeremy by connecting with him on LinkedIn.