In his book, Boombustology, Vikram Mansharamani sets out how you might be able to identify that an investment bubble is inflating.
However, he admits that he cannot tell you when the bubble might burst.
Mansharamani tells us instead that we have a choice – and that this choice is best defined by the potential error we might be making.
This approach can apply to investment at any time, not just at a time when a bubble is forming.
The two errors are:
-The error of omission (not doing something)
-The error of co-mission (doing something).
If you identify an investment bubble, Mansharamani suggests that it is better to make the error of omission – in other words, don’t continue to invest, with the result that you miss out on that last bit of profit as the bubble continues to inflate; it is better to get out early than late.
This action can be harder to do than you might imagine – towards the end of a bubble, your friends will be telling you about the gains they have made, and the media will be busy explaining how “it’s different this time”.
Very intelligent people have made the error of co-mission – Isaac Newton (who knew a thing or too about things falling!) lost his life savings in the South Sea bubble, having previously made a handsome profit.
Had Newton made the error of omission, rather than co-mission, he would have been a far wealthier man.
In the context of retirement, consideration of the type of error, which you might be making, can help you to determine your general investment strategy.
If you make the error of omission by not investing, will this hurt you more than making the error of co-mission, by investing at the wrong time?
In the first case, you would find that your retirement savings would gradually lose their spending power, as a result of the impact of inflation; in the latter, your savings might suffer a dramatic fall, and take years to recover.
When you are several years away from retirement, the error of co-mission may be less unattractive, as you still have time for your portfolio to recover and benefit from long term returns.
But as you approach retirement, the error of omission is instinctively more appealing (although some of your retirement income portfolio should always be invested with the long-term in mind as you should expect retirement to last for 30 years or so).
As financial planners, we are often asked about when the next financial crash is coming.
We don’t know, although Mansharamani’s book does give us a framework to determine whether a bubble is inflating (more about that in future posts).
What we can do, however, is to help you to determine how you might be affected if you choose to stay invested (and there is a crash) or if you switch to cash (and there isn’t a crash).
Having considered this, you can decide which error you can afford to make.
