Are We In A Stock Market Bubble?

A question I’ve been getting lately is whether the stock market’s all-time highs can continue. They want to know, are we in a bubble?

There are a number of indicators that suggest we could be. One is net margin debt. Margin is a Wall Street term that means borrowing money to buy and sell stocks. When times are good, this can be very lucrative. Margin traders are able to buy more stocks than they could otherwise, meaning more profit when those stocks increase in value.

However, when times aren’t so good, it has the opposite impact: Margin traders lose money on their investments but still have to repay that borrowed money. If a trader borrows more than they can repay after losses, they quickly find themselves in trouble. If a lot of traders do this, the market itself can suffer.

At the end of May, net margin debt in the U.S. hit 1.25% — a level that hasn’t been seen since the ‘90s. That’s a sign that we could be in a market bubble.

When people ask me if we’re in a bubble, what they usually mean is that they want to know when they should sell their investments to avoid losses when the bubble bursts.

The main problem with timing the market is that while we can generally observe that markets experience periods of gains and declines over time, we cannot say with any certainty when these changes will occur.

This suggests that successfully timing the market may rely more on luck or predicting the unpredictable, rather than on investment expertise alone.

People are often tempted to time the market because they’ve heard anecdotes about people who did and became fabulously wealthy. But less alluring are the anecdotes of people who timed it wrong and lost their shirts.

A solid financial plan built to take advantage of good times while being protected from bad times is going to give you a much better chance at building wealth over time than one that treats the stock market like a slot machine.

Investment plans are not a one-size-fits-all product. When one is built, an individual’s unique financial situation and circumstances should be considered. When building your plan, ask yourself:

• How far away from retirement are you?
• What is your risk tolerance?
• How can you diversify your investments?

The closer you are to retirement, the more conservative your investment strategy should likely become. Those who are further from retirement have additional time to possibly recover from losses before they need to tap into their accounts. However, if you’re within five years of retiring, you may not have that luxury and could be forced to withdraw money from investments when they’re bottomed out.

Risk tolerance is a vital consideration. A financial plan can look great on paper, but if you’re the type who will “panic-sell” if you see the value of an investment dropping, it could unnecessarily risk your investment returns and delay, or even prevent, your retirement.

Finally, by diversifying your investments, you help shield your portfolio against losses from bad days. Proper diversification doesn’t just mean owning stocks in different companies, as that only protects against individual asset losses, and not against the entire market suffering a downturn. By diversifying into many asset classes, such as stocks, bonds and real estate, your portfolio is better able to withstand a burst bubble in one market.

Investing is complicated, which is why it’s a good idea to work with a financial professional who can help you determine the best plan for your unique situation.