Don’t Let Bubble Fears Dictate Your Investment Strategy

Key Takeaways  

• Bubbles occur when investors buy regardless of price; disciplined value investing focuses on reasonable valuations instead.  

• Market timing consistently fails; diversification and rebalancing protect portfolios better than attempting to predict bubbles.  

• Historical bubble scares show that patient, diversified investors outperform those who panic or exit markets prematurely.  

• Regular portfolio stress-testing ensures financial goals remain achievable even if significant market downturns occur.  

Lately, I’ve heard from several clients who are uneasy about the stock market. That’s not surprising.   The Wall Street Journal recently asked Are We in an AI Bubble? What Happens If It Bursts? When words like bubble start circulating, anxiety tends to follow and generally leads to more questions such as “What is a bubble? “ and “If a bubble is forming, how should I adapt my investment strategy?”  

Let’s examine these questions in more detail.     

A bubble describes a period in time when irrational exuberance causes investors to buy an investment regardless of price. This goes against one of the core tenets of our investment philosophy as value investors. Price matters. The price of an investment contains so much useful information. We rely upon market pricing every day in our lives.   

For example, I enjoy eating salmon for dinner and like buying it the same day. When I go to the grocery store, the price of salmon reflects current market pricing based on the supply of salmon that day and how many people lately have been wanting to buy salmon for dinner. However, there is a limit to how much I’m willing to pay to have salmon for dinner. In a “salmon bubble,” shoppers are willing to pay any price to have salmon for dinner. As a value investor (and food shopper) there is a limit to what I’m willing to pay to have salmon for dinner. The same concept holds true with investing and technology companies.   

I believe AI is going to have a significant impact on our economy just like the internet did when it became widely adopted. However, companies still need to have earnings and show a profit. I’m not willing to pay any price to own more and more of these AI-driven type of stocks.  This approach is one of the reasons why we don't use simple index funds, because they essentially buy stocks in the index regardless of price. 

It’s natural to feel concerned when the markets in general, and the technology sector in particular, have been performing so well over the past several years. Behavioral finance calls this “negativity” bias. It’s our brain’s natural inclination to think all good things must come to an end. People tend to think  investing is all or nothing. For instance, they’ll say: “The market is overvalued, we need to be in cash” or “we need to be all in one sector of stocks.” Taking investing to these extremes is not a great way to invest.  

Look at the U.S. stock market in the late 1990s. Stocks started a huge run in the mid-90s and by 1997, many people were warning about a bubble forming. If you listened to them and got out of the market then, you missed out on a massive amount of returns as stocks generated three more years of double digit returns from 1997 through 1999.  

Evidence shows that no one can consistently time the market. The best way to invest is to be broadly diversified. If a bubble seems to be forming in a specific area of the market, or when prices seem outrageous relative to company earnings, it's a good time to take some profits, but not get out entirely.  

Being disciplined and sticking with an investment plan forces you to rebalance. For our clients who are living off of their savings, we  raise cash from the area of their portfolio that is performing well to help meet their expenses. For clients still working and saving, we can take some profits and move the money to another area where the investment prices are more attractive. 

Don’t Let Bubble Talk Dictate Your Strategy 

 When people start saying a sector is in a “bubble” it creates understandable anxiety. But perception alone is not a reason to overhaul a long-term investment strategy. Markets are volatile and unpredictable. Discipline is essential. Sometimes one sector feels overheated. Recognize that feeling and remind yourself that headlines don’t equal certainty. No one can reliably call a bubble in real time.  Not economists, not analysts, not your uncle who “saw 2008 coming.”   

Diversification  

If you’re a Novi client, you are sufficiently diversified across sectors, across asset classes and across countries. Diversification isn’t a luxury; it’s the seatbelt that keeps you from doing something dangerous or reckless to your plan when emotions get the better of you. Diversification is built specifically for periods when certain investments appear overpriced, underpriced, or simply unpredictable. A well-diversified portfolio is designed to withstand the drama of market cycles, which includes bubble-forming from time to time. 

As with trying to time the markets, there’s no evidence that investors can consistently sidestep their way around bubbles. In fact, trying to sidestep a bubble often causes more damage than the bubble itself. Instead of guessing which sector is “the next to pop,” a responsible advisory firm like Novi rebalances. We use global and sector diversification that considers investment valuations. We stress-test portfolios to see potential outcomes, not to predict the future. This helps us keep investment decisions anchored to our client goals, not to market headlines.  

Historical Context 

Today’s market is hardly the first “bubble scare.” Think dotcom in 2000, housing in 2008, crypto swings throughout the pandemic, etc. Each of those periods demonstrated that diversification and patience consistently outperform panic and guessing. Those periods were nerve-wracking for many investors, but as disciplined investors, we looked at those periods as opportunities for people to buy good companies at favorable prices. That was certainly the case during the global financial crisis of 2008-2009. Many investors who didn’t have skilled advisors and who didn’t remain disciplined during those scary times, still haven’t recovered their losses. 

I remember back in 2018-2019, many experts were warning that tech was poised for a big pullback. If you had listened to the headlines you would have missed out on five straight years of double-digit gains. 

At Novi, we are fiduciaries. A fiduciary can’t and won’t make bets based on speculation. Our duty is to uphold prudence, make investment decisions based on evidence, and to recommend actions that we feel will result in  long-term success for our clients.  

Your investment strategy shouldn’t swing with every headline. A well-constructed diversified portfolio already accounts for the possibility of overpriced sectors. As Novi clients know, we stress-test portfolios whenever we do regular updates with them. For instance, if your portfolio drops 15% over the next year and another 7% the year after that, are you still able to reach your goals? How does that impact your probability of success? Regular stress testing ensures that even if a bubble bursts and we see a drop in portfolio values, you’re still going to be able to meet your financial goals.  

Contact me any time if you’d like to review your allocation or long-term financial plan.  

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RYAN M. VOGEL, CFP® is the CHIEF PLANNING OFFICER, PARTNER at Novi Wealth