How do you invest during a bubble? – A wealth of common sense

A reader asks:

You said you think AI is a kind of bubble. Bubbles eventually pop. What can investors do if they agree with you and want to prepare for that doll? Or is there nothing you can do than the Golf driving? Even if a bubble is clear, what do you do about it?

Jeremy Grantham van GMO is an expert in the field of financial bubbles.

Here is something he wrote about the current cycle:

The long, long bull market since 2009 has finally grown up to a full epic bubble. With extreme overvaluation, explosive price increases, crazy issues and hysterical speculative investor behavior, I believe that this event will be recorded as one of the big bubbles of financial history, together with the South Sea Bubble, 1929 and 2000.

These large bubbles are where fortunes are made and lost – and where investors really prove their courage. To position a portfolio, it is probably the most difficult part to prevent the worst pain of a large bubble fracture. Every career stimulus in industry and any mistake of individual human psychology will work to suck in investors.

But this bubble will burst in due course, no matter how hard the Fed it tries to support, with harmful effects on the economy and portfolios. Make no mistake – for most investors today, this can very well be the most important event of your investment lives. Speaking as an old student and historian of markets, it is at the same time intellectually exciting and frightening. It is a privilege to drive through a market again.

Investing in most market environments is equally exciting and frightening. But the way Grantham describes the current market setting sounds scary.

Here is the problem – Grantham wrote this in January 2021. Despite a bear market in 2022 and the Liberation Day Kerfuffles earlier this year, the S&P 500 90% has risen since he wrote this. The Nasdaq 100 has doubled.

That is a return of around 15% per year.

These things are not easy to predict, even if it feels like the sequel to a film that we have all seen before.

All that meme share and spac madly in 2021 felt like a mini-mania but no bubble burst. I don’t want to put words in his mouth, but Grantham would probably say that we have just created an even bigger bubble with the AI ​​spending.

The enormous amount of expenditures for the AI ​​-Buildd -out for sure feel Such as some of the earlier innovation investment bubbles of history. The problem is that everyone knows when we are in a crisis, but nobody really knows when we are in a bubble.

Nobody can say it for sure, but because of the argument, let’s say that this is a bubble. What should you do as an investor who gets entangled in the middle of a speculative mania?

The way I see it, you have four options when investing in a bubble:

1. You could go all-in. George Soros once said, “When I see a bubble forming, I hurry to buy, add fuel to the fire.”

You could try to be Soros and drive on the Golf. Who knows how far this AI stuff can go?

Maybe Nvidia will be the first $ 10 trillion company? Oracle can hit the Quad Comma Club and become the next trillion dollar corporation. Mark Zuckerberg could get AI to steal all our sofi numbers before everything is said and done.

Who knows how long this will take? Perhaps all-in will continue to bear fruit on AI-related shares.

However, this is the type of strategy that works gloriously until it doesn’t.

You need an exit strategy if you try to be the next Soros.

2. You could cover. If you are really nervous, you can go to cash or buy bonds or buy wells or invest in a sort of covered strategy.

The problem with this strategy is that market timing is always difficult, but even more in a bubble -like situation. There is no science behind how far the pendulum will swing from one extreme to the next.

What if you miss a melt-up?

Are you comfortable to deal with FOMO?

How do you know if you are wrong?

Go all-in or all-out is extremely difficult, not only because timing markets are difficult, but because it always weighs on your psyche.

3. You can diversify. Even if you are 100% sure that we are in a bubble, you don’t have to go everything or nothing.

You could simply diversify your portfolio from the MAG 7 Hyperscalers.

There were other areas of the market from the Dot-Com-Buste that did well, despite the fact that technical shares were slaughtered. See how well the value of the small cap and bonds did during the DOT-Com-Buste:

The Nasdaq 100 was written after the insane technical run from the late nineties. But small caps and value shares did not keep pace during that approach network as the current cycle and they performed better than the bubble in a large way.

The implementation of other asset classes during the lost decade for the S&P 500 in the 2000s is a poster -child for diversification:

I do not suggest that this cycle will come out, just as the DOT-Com Bubble did, but there are many activa classes, strategies and regions that are not nearly as high as the gigantic technical shares.

Diversity can be difficult when the return is concentrated, but it is a great way to protect yourself when that concentration stands its ugly head to the disadvantage.

4. You can’t do anything. Doing nothing is also a choice. As long as you have an investment plan that fits your risk profile and time horizon, the best step here might be to follow your plan.

Stay the course, come what is there.

You just have to be sure that you have an active spread and investment strategy that you can keep to hell or high water. You have to be comfortable with going through drawdowns and avoid volatility and FOMO because you do not always change your portfolio like some investors.

Doing nothing is a simple strategy, but it is not easy in any way.

I don’t do anything with my portfolio. I do not make any changes. I remain diversified, balanced again in balance and continue to contribute to my various accounts.

Whether it is a bubble or something else, I know that having a stock-heavy portfolio occasionally means that you are uncomfortable and part of my portfolio is evaporated. For me, the long -term returns are worth the risk.

You really just have to weigh the considerations and perform a little regret minimization to determine which route you have less regret:

• Potential abuse of further profit?
• Participate potentially in large losses?

Life would clearly be easier if you could just drive higher on the AI ​​wave and step off if it is about to crest, but that is not a realistic strategy.

Experience has taught me that nobody has the opportunity to consistently predict the turns in this cycli.

So I’m not going to try.

I discussed this question about the last episode of Ask the Compound:

We have also discussed questions about the use of equity in pension planning, how to balance the expenditure versus saving, when it is useful to pay for a financial adviser and what the higher middle class in America is.

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The weirdest bubble ever