What I am trying to illustrate to readers is a key investment phenomenon which could save them a fortune and protect their wealth. The phenomenon I am referring to is an 'investment bubble'.
An investment bubble is when the valuation of an asset increases unrealistically. The over inflated price (the bubble) eventually bursts when reality and investment fundamentals catch up, sending the price plummeting back to earth with a jolt, often leaving investors (usually the general public) out of pocket.
Bubbles occur all the time and are largely driven by the availability of credit. Easy money chases a finite asset class which then inflates the asking price. A good example was the UK property market bubble which peaked in 2007 to then subsequently burst leaving swathes of home owners in negative equity.
Spotting bubbles is not always easy, after all human nature is to invest in something when prices are going up and sell when they are falling which exaggerates any boom or bust - both bad ideas for long term investors. But it's important to control your emotions when investing if you want to make money and preserve your wealth.
So how do you spot an investment bubble? Well a picture paints a thousand words and the diagram below beautifully sums up how a bubble forms and bursts. Click on the image to enlarge it. You can see there are 4 distinct phases.
Now what has this got to do with a cab driver? Look at phase 3 - the Mania Phase. The institutional investors have already made their money by this point but the general public are now piling in. The media is now full of coverage on whatever asset is flavour of the month- remember all the property programmes which filled the TV schedules in the lead up to 2007?
Now it's at this point that one day you will probably be in the back of a cab chatting to the driver and he might tell you about his plans to (or someone he knows) get rich on 'doing houses up'. I'm not picking on cabbies - it's just that they are about the best barometer of public opinion I have come across given that they interact with such a diverse segment of our population in the course of their job. If it's not a cab driver then it could be your mate down the pub. As soon as these people start giving you investment advice or ideas alarm bells should be ringing. So listen to them and then do the opposite (or at least reassess your portfolio) and protect your wealth.
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