One of the most disappointing, and potentially devastating, occurrences in your financial life is likely to be the realization, too late, that your investment has been in the bubble. One day you are flying high, sure your fortune is made, and the next day you are crushed — and possibly looking at large losses. While it may be a boring way to invest, you may want to avoid investments that are in bubble mode. Here are 6 signs that can help you identify an investment bubble.
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When looking at an investment, especially for long-term success potential, there are a number of fundamental factors to consider. These include everything from solid management to dividend payments to market share to place in the economy. However, when an investment is in bubble mode, few are looking at the fundamentals. And when you do look at the fundamentals, they don’t seem to support the price action.
If the foundation looks shaky, but the price keeps moving higher, it might be a good time to get out — before you get caught in the bubble’s burst. An investment with solid fundamentals may lose out during an economic downcycle, but the losses won’t be as huge as those seen by a bubble investment, and an investment on a solid foundation is more likely to recover in the long-term.
One of the signs that an investment is in bubble mode is that its price shoots up in a relatively short period of time. Prices on residential real estate were rising rather quickly in a period of a few years, as compared to past gains in real estate. Another consideration is if prices increase by 50% in a year. The problem is that most investments just can’t realistically maintain that pace.
When the mainstream media starts running stories about how this is the “next big thing”, and continually talks up how the investment continues to do well, without analyzing the fundamentals, you could very well have an investment in bubble mode. When you are seeing nothing but good things about an investment in the media, and stories proliferate about how people are making money hand over fist, it might be a good time to get out — a burst bubble could be around the corner.
If it seems that everyone around you is getting in on the action, and they are starting to feel confident in their ability to make money in the market, you know that something is off. When people’s investments go well, they tend to give themselves more credit than is due for their insights into the market — especially if an investment in bubble mode is gaining in price. If everyone you know is trying to get in, it might be time to avoid that investment. The truth is that by the time the amateurs get in on something, the pros have already ratcheted up the price. They make money as they sell in droves, and the followers are stuck with the losses as the bubble bursts.
Just before the real estate bubble burst, you couldn’t watch TV or read a magazine without seeing some ad for a seminar or program about how you could make money fast with a special system for buying and selling real estate. Right now, as gold continues to gain, more ads are springing up about making your fortune fast in the precious metal. Is gold a bubble? Maybe not. But you might be unpleasantly surprised if you think you are going to get rich on a “sure thing” like using gold coins (or any other investment) to shore up your finances.
They may not use those words, but when a bubble is investment mode, people speak as though some shift has occurred that marks the end of a downcycles. There seems to be a real belief that appreciation is the only direction for the investment. The truth, though, is that there are always downs. And if the ups have been dramatic, the downs are likely to be just as dramatic.