Blowing Bubbles

The company had no problem attracting investors desperate for a place to put their money.  People rushed to purchase shares so they wouldn’t be left out, scraping together whatever money they could, seeing only boundless opportunities for gain.

Excitement and tension increased in the same proportion as the increase in stock prices.  Plans were made for spending their newly acquired wealth.

Related: Do Stock Market Cycles Influence Your Investing Behaviour?

Then, share prices started falling.  People started panicking and sold their shares – many lost everything.

Does this sound familiar?  It shouldn’t (except in a history lesson) because it happened in 1719-1720 and is known as the South Sea Bubble.


Another famous bubble was the tulip bulb frenzy in the 1630’s.  The novelty of tulips made them widely sought after and, therefore, pricey.  The increased scarcity and demand drove prices up so fast and so high that one-month showed a twenty-fold increase.

Related: Market Efficiency – A Glaring Oversight In Passive Investing Strategies

At the peak people were trading their estates and life savings for one tulip bulb.

Why is it called a bubble?

A bubble occurs when investors put so much demand on an investment that they drive the price up beyond any rational reflection of its actual worth.

It often appears as though the investment will rise forever.

Compare this effect to Bazooka bubble gum.  People of a certain age will remember this appalling, latex-textured gum with its enclosed corny Bazooka Joe comic.

RelatedInvesting In Collectibles

The gum could be blown into a fair sized bubble.  The larger the bubble, the thinner it got, which meant it started getting bigger and bigger – until it exploded all over your face and got stuck in your hair and eyebrows.

Investment bubbles follow the same process: a period of reasonable growth then a remarkable rise that accelerates even further.  Prices climb so rapidly that what should make them obviously ridiculous becomes perversely attractive instead.

Near the end of every bubble more investors feel compelled to join in – causing the process to gather speed, until its inevitable implosion.

Modern day bubbles

High-tech bubble: Who can forget the “dot-com” craze?  Computers and their technology were the latest thing, and investors wanted big, new ideas and advancements more than a solid business plan.

RelatedThe Beginner’s Guide On How NOT To Start Investing

In 1999 there were 457 IPOs issued, most of which were internet and technology related.  Of these IPOs, 117 doubled in price the first day of trading.  When the bubble collapsed the Nasdaq lost 78% of its value.

Housing bubbleHouse prices were soaring and interest rates were low, leading to real estate speculation and questionable lending practices as consumers viewed their homes as a “piggy bank” that they could extract cash from.

Mortgages were re-packaged and turned into AAA-rated securities (exceptional degree of creditworthiness according to Standard & Poor) and sold to investors who were seeking higher returns as well as to pension funds and mutual funds around the world.

Prices on these mortgage-backed securities eventually plummeted, prompting large losses for banks and other financial institutions and shares fell hard.  Consumers lost big time when house values and retirement funds plunged in value.

What’s next?

Will we be facing another stock market bubble?  From tulip bulbs to gold, if there’s lots of money to be made we want to be in on the rush.

Will it be in commodities, as emerging countries begin their own industrial revolutions?

Will there be another high-tech bubble?  The highly anticipated Facebook IPO was the biggest in technology history even with the claims that the initial price was too high and not supported by potential revenue.

People were chewing their fingers when the Nasdaq had some technical glitches and orders couldn’t be filled.

Related: How To Avoid These Four Investing Mistakes

Apple shares had a record high of over $700 in September of last year.  The price has since dropped but is still almost double the previous high in December 2007 ($199).

The Dow Jones Industrial Index is also reaching record highs on increased US corporate profits (even though many large corporations received free money from the Federal Reserve).

What can we learn?

For future investment success we should learn positive lessons from bubbles – such as the importance of diversification and independent research and staying with your planned asset allocation.

The unreasonable belief in the possibility of getting rich quick is the primary reason that people get burned.

Big leaps in share prices should be justified by the future prospects of the underlying companies.

Related: Why I Became A DIY Investor

Keep yourself informed and keep your emotions in check.

(Source on market bubbles: Investopedia)

Print Friendly, PDF & Email


  1. Money Beagle on May 29, 2013 at 5:34 am

    I have a post coming out tomorrow where I give my thoughts on whether there is a bubble or not in the market. I’ll give a sneak peak by saying that balance sheets have been improving dramatically for companies…so that might give an indication of which way I’m leaning 🙂

    • Boomer on May 29, 2013 at 8:19 am

      @Money Beagle: I look forward to reading your views.

  2. Robert on May 29, 2013 at 6:00 am

    I suppose if you predict enough events, some of them will pan out. I tend to have the unwavering belief that the future will always surprise. Boomer’s “what can we learn” paragraphs provide some wisdom in this regard as they point to dealing with future uncertainty.

    • Boomer on May 29, 2013 at 11:27 am

      @Robert: The stock market rises and falls naturally and some company shares can increase considerably based on things like high demand (Apple) and new, innovative products (original Blackberry) which is usually not sustainable in the long run.

      Some prudent people sell and crystallize profits. Others who normally wouldn’t make the investment hear of all the money their friends are making and become afraid of missing out – so they buy at near peak levels and then panic when the price drops.

      While we all want to make money – excessive greed for fast and easy riches is not the way to determine your portfolio purchases.

      • Robert on May 29, 2013 at 12:18 pm

        @Boomer. I agree with most of what you replied to me although I cannot see the connection to what I wrote.

        Personally I have little interest in hot stocks. People may make money on these short term plays but the bet is largely on the emotions of the market. I prefer to place stock bets on business concerns which have much longer cycles than human whims.

  3. Glen Craig on May 29, 2013 at 9:07 am

    I think once the lay-person hears about some industry making tons of money then you are getting close to a bubble burst. If you see it on TV all over then forget about it. We as individual investors are probably the last to get any real information. So once you think you are going to invest in something and make a ton of money quick it’s already too late. Slow and steady wins the race here not hot-for-today investments.

    • Bryan@Fatwallet on May 29, 2013 at 9:16 am

      Pretty much this.

    • Boomer on May 29, 2013 at 11:31 am

      @Glen Craig: Once you start hearing about fast rising investment products from your waiter, hairdresser and realtor, you should know it’s got to be pretty close to the peak.

      You are so right – slow and steady and smart is the way to go.

      • Bryan Jaskolka on May 30, 2013 at 9:56 am

        See, I have to disagree. I think that may have once been the case, when it took forever for the word to trickly down to the common person. However in today’s social media age, where everyone knows way too much about what people are doing all the time. I stay away from the stock market, so I can’t analyze on that aspect. But I don’t think that just because people hear about high real estate prices it means that there’s a bubble forming. You don’t even have to go out and buy a paper anymore to find out the YOY or month over month differences. Just turn on your laptop and check out the latest headline blaring back at you.

  4. Bet Crooks on May 30, 2013 at 7:36 am

    My personal guess is that gold has been the latest bubble. For sure if you look at its long term price vs its price since 2006 it looks like a bubble ready to pop, to me at least. I’ll be interested to see its value in 5 years. I’m not worried about it though as I don’t hold any.

    Bubbles make a good argument for asset diversification: some stocks, some bonds, some cash/GICs, some real estate, some gold. Maybe a few tulip bulbs, beanie babies, or baseball trading cards…..

Leave a Comment

Join More Than 10,000 Subscribers!

Sign up now and get our free e-Book- Financial Management by the Decade - plus new financial tips and money stories delivered to your inbox every week.