Bubbles Come in All Shapes and Sizes

July 11, 2013

After reading my colleagues’ blog posts this week about their best and worst investment decisions ever, I’m glad that I was in college until 2000 and missed the dot com bubble of the late 90’s. As a college student, I didn’t have money to invest in the likes of pets.com even if I wanted to. Instead, I got to watch the rise and fall of the “New Economy” stocks from a distance. The only thing better than learning from your mistakes is learning from other people’s mistakes.

Those lessons came in handy during the following real estate bubble. Everyone around me seemed to be making tons of money in real estate and I was very tempted to purchase a townhouse in the DC area with one of those notorious interest-only loans. My plan was to rent it out to make the mortgage payments and then sell it for a profit. The only problem is that the down payment and closing costs would wipe out almost all of my savings and the rental income wouldn’t have been enough to cover the mortgage payments so I’d have to put extra money into it every month. Still, with the power of leverage and the way that real estate was appreciating back then, the return on investment seemed better than if I invested that same money in the stock market.

In the end, I didn’t buy the property since I didn’t know as much about real estate as I did about stocks and I didn’t feel comfortable being that financially stretched, especially for something I didn’t completely understand.  That ended up being my best investment decision as this was 2005, just before the real estate market plummeted. If I had purchased it, I would be making payments on a home that would likely still be underwater today.

The worst investment decision I made wasn’t a conventional one. It was my decision to leave a well-paying job at a major investment brokerage firm to go to law school. At the time, the law degree seemed to be “free” since I was fortunate to get a full scholarship that even covered most of my living expenses. However, this former economics major somehow managed not to factor in the opportunity cost, which in this case was an additional several hundred thousand dollars that I could have saved over that time period if I had not foregone my paycheck.

The irony is that I never even intended to actually practice law so the financial value of the degree was even more dubious. Like many other graduate students, a large part of why I went back to school was because everyone else seemed to be. In a sense, I got caught up in a different kind of bubble as many of my fellow law graduates are now struggling to make payments on six-figure student loans in an over-saturated legal job market.

The point is that the stock market isn’t the only thing prone to bubble-type behavior. We can find similar bubbles in everything from real estate, to gold, to bonds and even in non-tangible investments like higher education. The lesson is to ignore the hype and the crowds, understand what you’re investing in, make decisions based on what makes sense for your particular needs, and be particularly careful about investments that require debt. As Warren Buffett once said “When you combine ignorance and leverage, you get some pretty interesting results.”