Warren Buffett’s bubble rule can help you avoid herd mentality

Warren Buffett is not only one of the world’s greatest investors, he also has a knack for sharing knowledge and turning complex topics into memorable statements that serve as great lessons on how to (or not to) invest.

One of Buffett’s sayings is particularly relevant today: “What wise people do at first, fools do eventually.” This metaphor, which originates from “Warren Buffett’s Essays: Lessons for Corporate America,” a book compiling Buffett’s annual letters to Berkshire Hathaway shareholders, reminds us of the shortcomings of rushing into hot investments after prices have already risen, a trend that has been common in recent years.

There is no telling when the next bubble will burst, but speculation in overvalued investments cannot continue forever. Early investors are able to sell their gains to the unsuspecting, and once the panic sets in, the prospects of late sellers evaporate.

The meaning behind the quote

With this statement, Buffett is essentially saying that wise people act early and fools act late. In investment circles, the wise ones are the ones who do their own research, buy undervalued stocks, and hold them patiently until the market realizes their potential. On the other hand, fools pile up investments after seeing that others have made a lot of money from them. Their goal is to make a quick and easy profit, but they are often too late to make a profit.

Buffett’s quote is linked to the psychology of fear and greed, two emotions that often determine how people invest and lead to poor decisions, and reflects his investment philosophy. Buffett made his money buying stocks that the market was undervaluing early on and stuck to his convictions rather than chasing trends and hoping to quickly capitalize on momentum.

Examples from the history of Wall Street

Buffett’s wise and foolish observation plays out every day in investment markets. Here are some moments that stand out as attracting a lot of attention.

Dot-com bubble

In the mid- to late 1990s, investors began to recognize the transformative potential of the Internet and invest in companies that seemed better positioned to turn a profit and whose valuations did not reflect this.

By late 1999, everyone wanted to buy Internet stocks and their seemingly endless upside potential, prompting “fools” to pile into any company in the sector, regardless of its fundamentals or price. Eventually, the dot-com bubble burst, and thousands of tech stocks went out of business.

Cryptomania

Cryptocurrencies have seen many highs and lows. Early adopters, or those who arrived later but did their own research and stuck to their convictions during bouts of volatility, have generally benefited.

Then there were the “fools”, who jumped in not because they understood the value of digital currency, but because they saw that they were making people rich. They bought during peak periods and then panicked and sold when investment valuation collapsed.

Why is this important today?

People have often rushed into buying investments they don’t understand simply because they appear to make others rich. Although there is an argument that technological advances have made this trend more prevalent today.

With the Internet, it has become much easier to invest and be tempted to buy assets that have appreciated in value. There are dozens of apps and trading platforms that allow you to trade instantly and at competitive prices. Many people give questionable advice on how to build wealth.

Many of these get-rich-quick offers are instigated by people trying to rally others into buying assets they already own to increase their value. But this is rarely revealed, and the fear of missing out on the opportunity to earn a lot of money can sometimes be too overwhelming to ignore.

Bottom line

When Buffett said, “What wise people do in the beginning, fools do eventually,” he was pointing out the drawbacks of blindly chasing trends and emphasizing the importance of sticking to basic investing fundamentals — doing your homework, buying low and selling high, being patient, and understanding that it may take some time for investments to pay off.