If you’ve been watching this year’s tech stock rollercoaster with an odd sense of déjà vu, you’re not alone.
Members of the market-watching media have noted the strong parallels between today’s tech sector and what went down when the dot-com bubble burst back in 2000. And those similarities—rising stock valuations, an increase in initial public offerings (IPOs), and a focus on buzz over basics—have some experts pondering if history is repeating.
If you—or your parents, or your grandparents—were affected by the 2000 dot-com crash, you may be wondering if there’s something you can do to help protect your portfolio this time around.
Here are five lessons from the dot-com bubble and the financial crisis that followed.
What Caused the Dotcom Bubble, and Why Did It Burst?
Back in the mid-1990s, investors fell in love with all things internet-related. Dot-com and other tech stocks soared. The number of tech IPOs spiked. One company, theGlobe.com Inc., rose 606% in its first day of trading in November 1998.
Venture capitalists poured money into tech and internet start-ups. And enthusiastic investors—often drawn by the hype instead of the fundamentals—kept buying shares in companies with significant challenges, trusting they’d make it big later.
But that didn’t happen. Many of those exciting new companies with optimistically valued stocks weren’t turning a profit. And as companies ran through their money, and fresh sources of capital dried up, the buzz turned to disillusionment. Insiders and more-informed investors started selling positions. And average investors, many of whom got in later than the smart money, suffered losses.
The tech-heavy Nasdaq index had climbed from under 1,000 to above 5,000 between 1995 to 2000. The gauge however slid from a peak of 5,048.62 on March 10, 2000, to 1,139.90 on Oct. 4, 2002. Many wildly popular dotcom companies (including Kozmo.com, eToys.com, and Excite) went bust. Equities entered a bear market. And the Nasdaq didn’t return to its peak until 2015.
What Can Investors Today Learn from the Past?
Every investment carries some risk—and volatility for stocks is generally known to be higher than for other asset classes, such as bonds or CDs. But there are strategies that can help investors manage that risk. Here are some lessons:
1. Diversification Matters
One of the most established strategies for protecting a portfolio is to diversify into different market sectors and asset classes. In other words, don’t put all your eggs in one basket.
It may be tempting to go all-in on the latest hot stock, or to invest in a sector you’re intrigued by or think you know something about. But if that stock or sector tanks, as tech did in 2000, you could lose big.
Allocating across assets may reduce your vulnerability because your money is distributed across areas that aren’t likely to react in the same way to the same event.
Diversifying your portfolio won’t necessarily ensure a profit or guarantee against loss. And you might not be able to brag about your big score. Over time though, and with a steady influx of money into your account, you’ll likely have the opportunity to grow your portfolio while experiencing fewer gut-wrenching bumps along the way.
2. Ignoring Investing Basics Can Have Consequences
Even as the stock market began its meltdown in 2000, individual investors—caught up in the rush to riches—continued to dump money into equity funds. And many failed to do their homework and research the stocks they were buying.
Prices didn’t always reflect underlying business performance. Most of the new public companies weren’t profitable, but investors ignored poor fundamentals and increasing warnings about overvalued prices. In a December 1996 speech, then Federal Reserve Chairman Alan Greenspan warned that “irrational exuberance” could “unduly escalate asset values.” Still, the behavior continued for years.
When Greenspan eventually tightened up U.S. monetary policy in the spring of 2000, the reaction was swift. Without the capital they needed to continue to grow, companies began to fail. The bubble popped and a bear market followed.
From 1999 to 2000, shares of Priceline Inc., the name-your-own-price travel booking site, plunged 98%. Just a couple months after its IPO in 2000, the sassy sock puppet from Pets.com was silenced when the company folded and sold its assets. Even Amazon.com’s shares suffered, losing 90% of their value from 1999 to 2001.
And it wasn’t just day traders who were losing money. A Vanguard study showed that by the end of 2002, 70% of 401(k)s had lost at least one-fifth of their value, and 45% had lost more than one-fifth.
Valuing a Stock
There are many different ways to analyze a stock you’re interested in—with technical, quantitative, and qualitative analysis, and by asking questions about red flags. It can help in determining whether a company is undervalued or overvalued.
Even if you’re familiar with what a company does, and the products and services it offers, it can help to look deeper. If you don’t have the time to do your due diligence—to look at price-to-earnings ratios, business models, and industry trends—you may want to work with a professional who can help you understand the pros and cons of investing in certain businesses.
3. Momentum Is Tricky
Momentum trading when done correctly can be profitable in a relatively short amount of time—and successful momentum traders can turn out profits on a weekly or daily basis. But it can take discipline to get in, get your profit and get out.
Tech stocks rallied in the late 1990s because the internet was new and everybody wanted a piece of the next big thing. But when the reality set in that some of those dot-com darlings weren’t going to make it, and others would take years to turn a profit, the momentum faded. Investors who got in late or held on too long—out of greed or panic or stubbornness—came up empty-handed.
Identifying a potential bubble is tough enough, and it’s only the first step in avoiding the fallout should it eventually burst. Determining when that will happen can be far more challenging. If day-trading strategies and short-term investing are your thing, you may want to pay attention to the trends and your own gut, and get out when they tell you it’s time.
4. History May Repeat, But It Doesn’t Clone
Sure, there are similarities between what’s happening with today’s tech sector and the dot-com bubble that popped in 2000. But the situations are not exactly the same.
For one thing, investors today may have a better grip on what the Internet is, and how long it can take to develop a new idea or company. Some stock valuations today are, indeed, stretched but not as stretched as they were during the dot-com bubble.
And though a strong recovery from the Covid-19 recession could prompt the Fed to cool things down in the future, Fed Chair Jerome Powell has said the central bank is in no hurry to raise benchmark short-term interest rates or to begin reducing its $120 billion in monthly bond payments used to stimulate the economy.
So though it can be useful to look at past events for investing insight, it’s also important to look at stock prices in the context of the current economy.
5. You Can’t Always Predict a Downturn, But You Can Prepare
The dot-com stock-market crash hit some investors hard—so hard that many gave up on the stock market completely.
That’s not uncommon. Investors’ decisions are often driven by emotion over logic. But the result was that those angry and fearful investors lost out on an 11-year bull market. You don’t have to look at every asset bubble or market downturn as a signal to run for the hills. Also, if the market decline is followed by a rally, you could miss out.
One strategy—along with diversifying your portfolio—may be to keep a small percentage of cash in your investment or savings account. That way you’ll have protected at least a portion of your money, and you’ll be set up to take advantage of any new opportunities and bargains that might emerge if the stock market does go south.
Investors should also really look at a company’s fundamentals as well. Does a business make sense? Does it seem like they can grow their sales and keep costs low? Who are the competitors? Do you trust the CEO and management? After deep research into these topics, if the company is still attractive to you, then it could make sense to hang on to at least some of the shares.
If you’re a long-term investor who’s purchased shares in strong, healthy companies, those stocks could very well rebound. But this is an incredibly difficult process that even seasoned investors can get wrong.
Asset bubbles like the dot-com bubble can have different causes, but the thing they tend to have in common is that investors’ extreme enthusiasm leads them to throw caution to the wind.
In the late-‘90s and early-2000s, that “irrational exuberance” led investors to buy overpriced shares in internet companies with the expectation that they couldn’t lose. And when they did lose, the dot-com craze turned into a dot-com crash. Investors who thought they had a piece of the next big thing lost money instead.
Could it happen again? Unfortunately, there’s really no way to know when an asset bubble will burst or how severe the fallout might be. But a diversified portfolio can offer some protection. So can paying attention to investing basics and doing your homework before putting money into a certain stock. And it never hurts to ask for help.
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