Why do Investment Markets have Bubbles?
By Paul Benson, financial planner and host of the Financial Autonomy podcast.
If you’ve ever seen a graph of any share market, you will know that whilst over the long term it tends to go up, the graph isn’t a straight line. Markets will go up, up, up over several years, only to fall back for a year or two, before re-starting their upward climb.
Research on US investors found that whilst over 20 years to the end of 2017, the S&P500 index returned 7.2%, the average share market investor experienced a return of 5.29% per year. The numbers over 10 years are worse – market return of 8.5%, compared to an average investor return of 4.88%. I don’t imagine Australian investors would be much different.
This under-performance of investors has been observed for many years, so what’s going on? And how does it relate to market bubbles?
Market bubbles, and their subsequent busts, reflect over-reaction. We bid up prices beyond that which makes sense, and then on the downward slope, we sell when we don’t need to, and prices go below what logic would dictate they should be.
These extremes have nothing to do with balance sheets and profit and loss statements, and everything to do with human behaviour.
Market bubbles don’t occur because investors are stupid. They happen because we’re human. We’ve learnt through thousands of years of evolution that if a lot of people are running in one direction, it’s probably wise to do the same.
So when markets keep rising, as we’ve seen in Australia over the past decade with residential property for instance, or when they fall, like we experienced with global share markets through 2008, our inbuilt, human reflex, is to jump on the band wagon.
Another thing that is happening is a concept known as Recency Bias – disproportionally considering things that have happened recently, and dismissing older information.
So why should you care about investment market bubbles?
The answer ties in with the statistics I mentioned in the introduction. Investors could have earnt almost 2% per year more had they not followed the madness of the crowd. They bought and sold when they should have just left things alone.
Read or listen to the full article here.
This information is of a general nature only and has been prepared without taking into account your particular financial needs, circumstances and objectives. While every effort has been made to ensure the accuracy of the information, it is not guaranteed. You should obtain professional advice before acting on the information contained in this publication.
A Note from Glenis Phillips of Financial Mappers
I urge you to subscribe to Paul’s fantastic podcasts Financial Autonomy. He has year’s of experience in the investments market and a wealth of knowledge.
Thank you, Paul, for sharing your insights on Investment Markets with our Financial Mappers readers.
Disclaimer: Financial Mappers does not have an Australian Financial Services License, does not offer financial planning advice and does not recommend financial products.