Tulips were the first, but won’t be the last. What forms a “bubble” and what causes them to burst? When a bubble bursts, it can hurt the economy and your net worth.
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In 1636, Netherlands, tulips were in great demand. At one point, the price of a single tulip bulb reached ten times the annual income of a skilled craftsman. Suddenly, the prices fell and the demand for tulips collapsed. How and why could the price of tulip bulbs rise at such outrageous heights? This is perhaps, the most famous example of an economic bubble.A bubble, is defined as what happens when the price of an asset, or other financial instrument, is not justified by supplying demand. It’s difficult to properly identify a bubble in the lead up to collapse. Bubbles are often identified only on hindsight, but here are a few of the factors that can lead to it. Some displacement occurs that changes the outlook [inaudible 00:00:49]. Excess of market liquidity can accelerate price gains. Too much money, from easy credit or large disposable incomes, starts chasing a limited number of assets. As wiser investors locked the sell, the market can become illiquid, prices fall and the bubble pops. When a bubble bursts, it can hurt the larger economy and even have a negative effect on your net worth. Take a lesson from the tulips and beware of the bubbles as you create your investment strategy. Give us a call and let’s talk about it.
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