Friday, April 06, 2007

Bubbles and Investor Behavior

Now that the real estate boom is so clearly a thing of the past, I wanted to share a little bubble related story and put it into context.

Two years ago, someone I know moved from Southern California to Northern California. That person owned a home in San Diego, and when he moved up here, he decided to keep his existing home and buy another one in Silicon Valley. His thinking was that the San Diego real estate market was too good to miss out on.

Buying a house in Silicon Valley is a tad on the expensive side, and this gentleman could not afford to own two expensive houses while maintaining his existing lifestyle. Unlike others who may be inclined to get into debt to finance their consumption, my acquaintance wisely decided to tighten his budget. He cut his cable service, started eating more home cooked meals, etc. He also decided to cut his expenses further by terminating his life insurance policy.

Unfortunately, what happened next could have been taken directly from a showtime movie. About a year ago, this gentleman was diagnosed with Cancer. He is fighting hard, he is optimistic, and has every intention of beating the disease, but in retrospect he understands the potentially disastrous consequences of the financial decision he made.

This is an extreme case of investor error escalating into a really bad situation. It amazes me that no matter how many bubbles we go through, there are always people willing to put their financial well being on the line and bet they can beat the market.

The one lesson I think everyone can take away from this story is that even if you decide to go for some risky investments you should never mess around with your financial safety net. Life insurance, health insurance, emergency savings fund and so forth are that safety net. Play with those and you may find yourself in some serious trouble.

1 comment:

Joel said...

Unfortunately, this is only one of what I suspect will be tens and maybe hundreds of thousands of shattered dreams caused by the real estate bubble.

I fear we are about to see a tidal wave of foreclosure which will make the Enron collapse look like child's play.