An investment bubble is essentially the opposite of diversification. Taken to the worst possible end result, an investment bubble would be having all of your investments in one asset class – say large US companies, for example. More prevalent is to be over weighted in a certain asset class.
Investment bubbles are most often the result of a lack of true rebalancing. One of the reasons we rebalance automatically for all of our clients is that investments bubbles are very destructive, and we do not want to leave investors exposed to their havoc.
There are many reasons why investor portfolios become over weighted in one asset class. The most common reason is that few investors rebalance or rebalance correctly.
When one asset class does overwhelmingly well, better than others for an extended time period, that class will have more comparative value than the others. If the gains in that class are not sold off and redistributed among the others, then a “bubble” is created.
But bubbles can grow even bigger than by simply not rebalancing. I fell prey to this myself a number of years ago.
It was the late 1990s and I was talking with a former investment advisor of mine. The topic was rebalancing. He suggested that rebalancing was any reallocation of funds that the investor or advisor chooses to perform. At that time, near the end of 1998, we decided to “rebalance” into more technology type funds. Tech had been doing well for a long time and most people thought it would continue doing well. There were other asset classes, international and small company stocks to be specific, that were not doing as well. With the help of my advisor I purchased more of the funds that were doing well by selling off those funds that were not doing as well. In doing so, I blew more air into the large US company bubble. I should have been selling Tech as it grew, but instead I doubled down on it.
When the market crashed in 2000, the asset class that corrected the most was the asset class that I owned the most of. Even worse, when I checked inside the different mutual funds I owned, many of those same companies made up the top holdings.
Why should I have thought that owning five different mutual funds that essentially owned the same companies somehow made me diversified? I shouldn’t have.
That was a mistake I vowed never to make again, and it was the seed that grew to lead me to open Cornerstone Wealth Partners.
On January 29, at the University Club of MSU, I will be discussing at greater length this important issue of investment bubbles. The same great food and atmosphere, as well as many of your friends in attendance, will make this an evening you’ll want to mark down on your calendar.
Email or call us right away to reserve your spot.