Why AI investors might want to be wary of investment bubble warning signs

Artificial intelligence (AI) was once confined to the world of science fiction, but over the past few decades has come to shape the modern world. 

It is a subject you have read about twice over the past year in our articles about why you shouldn’t take investment advice from AI and what the race towards “true” AI might teach us about the world of high-risk investments.

The AI sector has been in boom for a while now and may seem an attractive option to potential investors. However, its rapid success and the ballooning of the AI market have led to some speculation over whether there is an AI investment bubble that could be about to burst. 

Here is what you need to know about investment bubbles as they may provide warning signs of potential trouble ahead. 

AI stocks are soaring in 2023, but investor demand could lead to them becoming overvalued

According to Money, there is a lot of excitement around AI stocks, which has contributed to:

  • Chipmaker Nvidia seeing its stock price increase by more than 200% in 2023
  • Microsoft stocks rising by 40%
  • Shares in Google’s parent company, Alphabet, going up by 37%.

The dizzying performance of AI stocks over the past few years, and in particular 2023, has led some to speculate whether companies are becoming overvalued and if AI is becoming an investment bubble that may be about to burst.

A bubble – in economic terms – typically refers to a cycle involving the rapid escalation of the market value of a particular type or category of asset until the value far exceeds its intrinsic worth. This inevitably leads to the bubble “bursting”, which means investors try and offload the assets, driving down their value, as the market contracts. 

A recent notable example of a market bubble was the surge of investors to dot-com companies in the late 1990s and the subsequent crash in the 2000s. 

5 stages of an investment bubble that might prove to be useful warning signs

Investopedia outlines five key stages to an investment bubble, including:

  • Displacement – in which investors start to take notice of a new product, technology, market, or opportunity and begin to shift funds into the sector.
  • Boom – as momentum builds and increasing amounts of money are rapidly invested in the sector, in turn causing a sharp price rise in relevant stocks.
  • Euphoria – as prices skyrocket and investors reap the rewards, potentially ignoring risks around the corner.
  • Profit-taking – as those who realise the market has peaked begin to sell off their positions.
  • Panic – as prices begin to drop and a downward spiral sees an increasing amount of investors trying to offload their investments, pushing prices down further.

There is some belief that AI has gone through the displacement and boom stages and is now at “euphoria”.

Yahoo News reports findings from Morgan Stanley that cite figures from 70 prior market bubbles over the past 100 years. The firm found that the median returns averaged 154% in the three years leading up to a bubble’s peak. 

As firms, such as Nvidia, have seen increases of more than 200%, it has led some industry insiders to conclude AI may be a bubble that is about to burst. 

Now, this might not be the case, and AI could continue to thrive for the foreseeable future. However, it is important to keep an eye out for investment bubble warning signs and to take precautionary steps to protect your investments. 

3 simple steps to protect your investments

1. Invest within your own tolerance for risk and consider setting aside an emergency fund

One of the first things a financial planner will do with you, when discussing your financial plans or investment strategy, is to establish your personal tolerance for risk. 

It is important that you don’t overextend yourself and, if the worst occurs and you see losses, that you are prepared and capable of handling them.

It is why you might want to consider setting aside an emergency fund before opting to invest any hard-earned cash. This could involve three to six months’ worth of essential bills, such as:

  • Rent or mortgage payments
  • Utility bills
  • Groceries.

Having an emergency fund in place before investing ensures you still have enough money to cover your key outgoings and provide for your family. 

2. Diversify your investments to help mitigate potential losses with gains elsewhere

It is probably not a wise move to “put all your eggs in one basket”, such as moving the majority of your investment funds into a single investment, market, or sector – such as AI stocks. 

You could gain from a market boom, such as that occurring with AI, but it is vital that if your investment takes a turn for the worse, you have assets elsewhere that could produce the gains necessary to offset or mitigate potential losses.

Read more: Global market review – Why diversification is important for your investments

Diversifying your investments across various markets, assets, and commodities could help you reduce risk and stay on track to generating greater long-term investment returns.

3. Don’t allow your emotions to influence your decision-making – think calmly and logically

Human beings are prone to being influenced by subconscious, psychological biases that can affect our decision-making ability.

One of these, known as “herd behaviour”, can be prominent during investment bubbles. 

The worry that you could miss out on the potential rewards others might reap could push you into herd behaviour. It could cause you to follow through with an investment you’ve seen others make, rather than make your own informed decision. 

This might leave you vulnerable if the investment doesn’t work out and you see potential losses. 

It is important that you take the time to consider any investing decisions and view them through a calm, patient, and logical lens. 

Don’t go it alone – the right advice could help you steer clear of a potential market bubble

If you are interested in AI investments, but are worried about the possibility of being caught up in an investment bubble, it is important that you seek out professional advice.

At Delaunay Wealth, we can help you assess your options and find the best fit for your overall financial plans.

To get the conversation started, please email us at mail@delaunaywealth.com or call 0345 505 3500.

Please note

This article is no substitute for financial advice and should not be treated as such. To determine the best course of action for your individual circumstances, please contact us.

The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.