Becoming Financially Free Means Understanding What “Asset Bubbles” Are
— And how to spot them.
It scares me to death how people do not know what asset bubbles are.
Asset bubbles transfer wealth from those who don’t understand them to those who do. These assets bubbles go from one form of assets to another.
I never used to understand bubbles and it wrecked my ability to become financially free. I’d get caught up in the hype of asset bubbles rather than the reality of the fundamentals that explain the financial world.
To continue my obsession with simplicity when it comes to understanding money and investing, when I say assets I’m referring to stocks, bonds, gold, digital currencies, real estate, and cash.
Defensive assets are bonds, gold, and cash.
Offensive (growth) assets are stocks, digital currencies, and real estate.
Let’s look at a few asset bubbles:
- The 2008 recession was an asset bubble in US housing.
- The early 2000s recession was the result of a bubble in tech stocks.
- The 2011 all-time high in the gold price was another bubble that burst and came back down to reality. (Many die-hard fans believe the gold price has been suppressed artificially.)
- The 2017 bubble in digital currencies was the result of a bubble fuelled by investors speculating on a brand new asset class.
In 2020, many argue we’re in a debt bubble.
Others argue we’re in a stock market bubble. I think the world has been turned so upside down by an illness, that it could be a little from Column A and a little from Column B.
You could even argue that financial markets are nothing more than a never-ending series of asset bubbles.
What Causes an Asset Bubble?
It took me years of working in finance to understand that when people make money they can become delusional.
Psychology drives the investing world.
Asset bubbles are a result of the collective psychology of humanity.
There are two other components of asset bubbles: overconfidence and hype. Both are prominent right now. Many people have turned to trading stocks while working from home.
Here’s the worrying sign:
Last month, US executives sold stocks in their own companies as the S&P 500 rallies on. This is the biggest burst of selling since 2015.
People in the know are getting out of the stock market. Meanwhile, the retail traders using apps like Robinhood keep rushing into what looks like an asset bubble. This is why you must understand asset bubbles and what they look like.
Look at the Fundamentals
Overconfident, delusional psychology can only drive asset bubbles for so long. Eventually, all asset bubbles burst.
These are a few ways to spot an asset bubble:
- How much money is being printed out of thin air and disguised as quantitive easing and stimulus checks?
- What does the unemployment rate look like?
- What does the GDP of major countries like the US look like?
- What does the stock price of the largest companies in an index like the S&P 500 look like in comparison to their forward earnings?
That last one is my favorite. Tesla’s stock price is up 400% this year. CNBC reported that Tesla “could be the most dangerous stock on Wall Street.” Why? Tesla’s stock price trades at 159 times forward earnings.
Now even if you know nothing about investing or stocks — does that sound like overconfidence, or hype, or a bubble?
See, spotting bubbles is not so hard when you pay attention to reality.
The Key to Asset Bubbles Is Timing
Asset bubbles are your best friend when they are expanding.
Asset bubbles are only a problem when they pop.
In the case of Japan, their stock market crashed and still hasn’t fully recovered after 30 years. That’s the danger of an asset bubble followed by a market crash. If you time your investing right, then you can make money off asset bubbles. If you get caught in the bubble of your chosen asset class, then you can lose a lot of money or find it takes a long time to see things recover.
I don’t believe — unless you’re a financial professional with years of experience — that normal people can successfully time markets and buy the right assets at the right time, and sell the right assets at the right time.
Many novices get caught in the bubble, and lose a lot of money — robbing them of any chance to experience financial freedom.
One solution: diversify.
If a bubble in stocks bursts then another asset like bonds can cover the downsides. I don’t have all the answers but I do strongly believe that diversification is a strategy anyone can put to good use. It works well in life too. “Don’t put all your golden eggs in one basket,” they say.
With a global health crisis and the lack of any recession for the last 12 years, I believe there is a good chance we are in a stock market and real estate fuelled bubble.
If You Don’t Understand Asset Bubbles Then You Get Caught in the Hype.
In the early 2000s everyone was spruiking tech stocks.
In 2008 everybody was telling me to buy multiple investment properties to become a passive income badass. In 2017 the computer programmer I sat next to at work was telling me to buy all these random digital currencies that had been around for, literally, weeks.
And today, everybody is telling me to buy gold to offset all the fear, or get into the stock market to get rich and fight inflation caused by excess money printing. I have rejected all of this advice. I have always tried to focus on identifying bubbles instead.
A few of my close friends have become addicted to the “buy property” hype of the last few years. As a result they have tenets not paying rent and are struggling to pay their property investment loan. They went from the people driving the Mercs and BMWs, to the desperate folk trying to offload their properties in a recession to stay afloat and not go bankrupt.
This is the problem with bubbles: they catch you off guard.
Stocks and real estate are not always the fast-track way to getting rich. For many who don’t understand bubbles, these two assets make them poor.
If I’d listened to all the hype then I’d be stuck with a whole portfolio of real estate that would have created an enormous amount of stress for me as I tried to sell them, quickly, to pay off debts.
Avoiding enormous stress is worth paying a lot of money for.
What Can You Do?
There is no one strategy to becoming financially free. The takeaways from this story are simple:
- Know that markets are made up of bubbles. Therefore you can be the smartest man/woman in the room, or the dumbest.
- Be careful of the hype and overconfidence.
- Diversify the way you invest. All-in on anything can be dangerous.
- Get a reality check by looking at the fundamentals, not believing the lie designed to take your money away.
You can make a lot of money, stress less, and become financially free when you understand that asset bubbles are everywhere, and have been throughout history.
It pays to have a healthy sense of reality when you invest your money. Otherwise you risk becoming delusional.
This article is for informational purposes only, it should not be considered Financial or Legal Advice. Consult a financial professional before making any major financial decisions.