Avoid financial bubbles and invest for the long-term

In this article Romany Yousab, Financial Adviser in Nottingham, Hertfordshire and London reviews the dangers of stock market bubbles, and reminds clients why it is important to have a balanced investment portfolio and invest for the long-term. 

Beware of speculative shares and investments

During 2021 we have witnessed Bitcoin’s value reach new highs and then almost halving in value. Also, many new investors have lost money on GameStop shares. There are many bubbles in history that provide examples of where investors have invested in high-risk speculative shares and then lost money.  

Examples of previous bubbles

• The Dutch tulip bubble (1636–37) 
• The South Sea bubble (1720) 
• Japanese asset bubble (1986–91) 
• Black Monday (1987) 
• The dotcom bubble (1990s) 
• US housing bubble (2000s) 

Why do financial bubbles occur?

Financial bubbles happen when the price of a financial asset rises in excess of its real value, and bubbles arise out of the belief that anyone investing in them can make a quick financial gain. As the value of the asset rises more people invest until the price peaks and quickly collapses. This is often accompanied with further price falls as more people try and sell their assets.

Examples of historic bubbles

Tulip mania was a well-known speculative bubble in the seventeenth century. Tulips were seen as a status symbol when they were introduced from Turkey, and this increased the price of tulip bulbs. As the price was unsustainable the market eventually fell leaving tulip traders with bad debts.  

In the 1990’s the introduction of the internet age caused a growth in the value of internet companies and other technology shares, called the dot-com bubble. 

More recently GameStop shares, although not quite a bubble shows what happens when the price of a share is artificially inflated. The investors were trying to take on Wall Street and although the price initially went up to record levels the shares later plummeted in value. 

How to protect yourself from bubbles

It can be tempting because of the potential higher returns on offer to invest in speculative assets but it’s important to remember that these assets are volatile and can go down in price as quickly as they go up. We advise all our clients that stock markets are generally volatile, so it is always best to invest in a balanced portfolio that is diversified across different regions. 

How to spot the warning signs of a bubble

A sign of a bubble is when there are many speculators who force the asset price to rise. Sometimes these speculators are new to investing and don’t want to invest in the asset class on a long-term basis. This can also be accompanied by speculators moving between asset classes to maximise profits and the asset class being discussed in the media.

Remember to invest in high quality asset classes

We recommend clients invest in assets managed by fund managers who have considerable experience of managing portfolios. Their funds are normally invested in a wide-ranging number of companies, so you are confident you are investing in diversified funds. The fund managers research and meet the companies so they understand how they operate, and they invest in them knowing the underlying value of the business.

It is always important to remember why you are investing before you risk your money investing in a new asset class. Investors don’t want to miss out, but we recommend that you stay clear of bubbles and invest in diversified portfolios. Always remind yourself why you are investing and make sure you are not just speculating. Don’t allow your emotions to control your investment decisions. If an investment looks too good to be true it probably is, so be careful.   

How to build an investment portfolio to achieve financial goals

We remind our clients that investing should be considered on a five-year time horizon and we recommend investment products that suit your circumstances. At Thomas Oliver our financial advisers will review your financial situation and your risk profile before offering financial advice. We offer a free initial financial consultation so call us on 01707 872000 to book your meeting now. 

The value of an investment and the income from it could go down as well as up. The return at the end of the investment period is not guaranteed and you may get back less than you originally invested. The contents of this article are for information purposes only and do not constitute individual advice.