Do you remember the dot-com bubble we covered during the week 4 within the topic of ‘Understanding Risks and Returns’? This real-life example is a perfect illustration of how psychological factors can lead to irrational investment decisions due to biases.

In the late 1990s, the dot-com bubble is a famous example of how psychological factors can deter rational investment decisions. During this period, the internet was becoming widely accessible, and many investors believed that any company related to the internet would be immensely profitable. This belief led to a phenomenon known as herd mentality, where investors followed the crowd rather than making decisions based on fundamental analysis.

Imagine an investor named Lisa. She noticed that her friends and colleagues were making huge profits by investing in tech startups, even those with no solid business plans or revenue streams. Influenced by their successes and the media hype, Lisa felt a strong fear of missing out (FOMO) and decided to invest her savings in these dot-com companies, without conducting thorough research.

The Outcome:

Initially, Lisa’s investments seemed to be performing well, with prices skyrocketing. However, the bubble eventually burst in early 2000, causing the stock prices of many dot-com companies to plummet. Lisa’s portfolio lost a significant amount of its value, and she realized that she had invested based on hype and emotions rather than rational analysis.