Bubbles: A View From the Outside

We humans have been driving bubbles in assets of every stripe for generations.  From tulip bulbs to tech stocks to beanie babies and bitcoins, our potential for irrational speculation has no end.  If we are lucky, we avoid these traps, but that can be harder than it sounds.

In the last five years we have seen two wildly speculative and wholly irrational asset price bubbles: Gold and Bitcoin. I was, thankfully, not a participant in either (and neither were clients who listened to reason). But watching from the sidelines has its own costs. The emotional impact of a bubble, even from the outside, should not be overlooked. The pattern looks like this:

coindesk-bpi-chart
a) Huh, that’s interesting. That asset’s price is trending up. Well, prices do that.
b) Wow, it is way up. 100% this year!
c) Man it just keeps going. These suckers, don’t they know these trends are never sustainable?
d) Heeeelllloooo bubble! What a bunch of fools.
e) This is really overheating, I can’t believe it.
f) Umm. Did I miss something here?
g) Wow people are really getting rich. $1,000 a few years ago is now $66,000?
h) What if this thing is the future? What if this is sustainable? Am I missing it?
i) I missed it. I can’t believe it. Imagine what my performance would be if I even had a 5% allocation! I’m an idiot.
j) Hmm looks like it’s losing some traction.
k) Absolutely crumbling.
l) Vindication! I was totally right all along. Why do people keep falling for this? Good thing I am totally immune to this psychology.

(PS: You can do the same thing with gold prices:)

fredgraph gold 2014

And then the glory of schadenfreude hits you and you bask in the spectacular bursting of yet another bubble. When it’s all over, the feelings of redemption are wonderful. But in the moment, the pull can be irresistible. Even for experienced investors, even for those of us who have seen irrational bubbles come and go seemingly every five years, the emotions strike new each time. THIS one seems different. THIS one could be the real thing. THIS one is really going to cost us. THIS one is our chance to get rich.
There’s no escaping the emotions of a bubble. On the inside of the bubble, the emotions are the same, just the orders are reversed. We get the elation of being right temporarily, and then suffer through the terrible angst of loss for much longer. For those of us on the outside, we try to force ourselves to ignore the bubble, but we can’t. Watching Bitcoin skyrocket from the outside is entertaining, but we can’t pretend it’s not happening.

The emotions of a bubble are why I am constantly harping about having an investment policy statement. Does your IPS allow you to speculate with 5% of your money? Great, throw 5% at Bitcoin if you just can’t help yourself. If (hopefully) your IPS is more sensible and thoughtful about your hard-earned savings, it won’t allow you to get (your money) caught up in the next bubble, which will be right around the corner. Only you can decide if you are going to follow your IPS. So when you feel the pull of the next bubble, ask yourself two things:
1) Is this part of my strategy as dictated by my IPS?
2) Why did I bother writing an IPS in the first place?

The answer to the second question is: TO KEEP YOU FROM DOING IRRATIONAL THINGS LIKE INVESTING IN A BUBBLE. Do you see?

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