Why bubbles matter to even a cautious investor?

The creation and bursting of bubbles can have direct or indirect impact on the finances of even a very cautious investor.

If the investor is aggressive and has invested borrowed money during a bubble, the results could be disastrous. However, even for a conservative investor, there could be major impact if a large number of big investors have invested borrowed money. Such a situation can lead to severe economic consequences in the aftermath of the bursting of the bubble.

Less than a decade ago, we witnessed such an event, popularly known as the sub-prime crisis. Large banks, institutions, hedge funds and even some Sovereign funds borrowed heavily and invested the money in risky assets. The after effects were felt across the world and by all investors – aggressive or conservative.

I have written the following in the beginning of the Chapter 2.9 – The Sub-prime Crisis:

In early 2014, while referring to the global meltdown of 2008-09, an IFA asked, “How does one explain to a school teacher in rural India that her portfolio value dropped by around 50% because someone on the other side of the world defaulted on his housing loan?”

Think about it. The investor thought that she was conservative and taking least risk. What she did not know was that it was someone else’s action that impacted her.

Read and learn from history. It is a good protection against the stupidity of others and of your own.

#RidingTheRollercoaster – 217


First forecasting … and then denial

Ben Bernanke was asked in 2005 about the possibility of fall in housing prices in America. He said: “It’s a pretty unlikely possibility. We’ve never had a decline in house prices on a nationwide basis.”

We know what happened later.

When the house prices started falling in 2007, he further added, “The impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained.”

First came a forecast, which went horribly wrong and then came a denial that this is not e problem.

As Lao Tzu has said, “Those who have knowledge, don’t predict. Those who predict, don’t have knowledge.”

#RidingTheRollerCoaster – 188