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Investment Basics: What is an Investment Bubble?

investYou may have heard or even used the term “investment bubble” but few of us really understand what this means. The Washington Post published an article on “How to tell if an investment bubble is forming” written by Robert F. Bruner, dean of the University of Virginia’s Darden School, for those who would like to be able to avoid the financial missteps that accompany an investment bubble. Bruner notes that “Bubbles are best known in retrospect,” and if you have heard people lamenting (or you yourself lament) the ‘dot-com bubble” of the 2000s, then you know that many were unaware as the bubble was forming.

An investment bubble is not easy to define. Bruner describes a bubble as “a general notion of excessive pricing and irrational investing — but it lends no clarity or bright line to distinguish really dangerous conditions from benign optimism.” These times are characterized by quickly rising prices with lots of demand and excitement. Often, people who knew little about investing get into the game because of there is a lot of buzz and talk about something being a ‘sure thing.’

While the general population is becoming dangerously optimistic about the possibilities and potential windfall from popular investments, those in the financial world are not immune. Banks may make it easier to get credit and regulators may not be as vigilant as they usually are.

Bruner observes that these are not the only conditions that lead to a bubble but if you reflect on any of the investment bubbles you know of, you may realize that this perfect storm of factors may have preceded one.

If you are a novice investor concerned about how to invest why not seek the counsel of a Fee-Only financial advisor? While you are free to make your own decisions, a financial expert may be able to offer perspective that you can use to guide your investing decisions because excitement is not a replacement for research and sound financial management.