The dotcom bubble was an asset valuation bubble that occurred in the 90s. It led to a recession caused by highly speculative investments in internet-based businesses. The bubble burst in early 2000 after investors realized many of these companies had business models that weren’t viable.
Learn more about the dotcom bubble, what caused it, and some red flags that should alert you of similar speculative investing trends.
Definition and Examples of the Dotcom Bubble
The asset valuation bubble that occurred in the late 1990s and involving an influx of investments in internet-based businesses is commonly called the "dotcom bubble." Many investors poured money into these highly speculative dotcom companies despite them showing little to no potential for profitability. When the dotcom bubble burst, it contributed to the economic recession in 2001.
- Alternate names: High-tech bubble, internet bubble, technology bubble, dot-com crash, dot-com bust, dot-com meltdown
The dotcom bubble is just one of many bubbles in U.S. history. Bubbles commonly occur when the price of an investment vastly outpaces its actual value—in this case, the value of internet-based businesses. Another famous example was the housing bubble that peaked in 2005.
How Did the Dotcom Bubble Work?
The internet was a hot topic during the 1990s and this led many investors to predict a profitable future in internet-based businesses. This resulted in increased investment in tech startups, which drove their price shares to higher levels. Many companies even changed their names to include “.com,” “.net,” or “Internet”—this simple change contributed to those companies outperforming their competitors by 63%.
The bubble was at its peak when intraday trading on the NASDAQ exchange hit 5132.52 in March 2020, only to pop later that year.
The value of many tech companies nosedived after investors realized these companies had little to no hope of turning over a profit. This led to panic selling and, by the end of 2000, the NASDAQ dropped by over 50%, dipping below 2,500 in December 2020. This triggered a recession in March 2001, leading many companies to close. People lost their investments and for tech employees, their jobs.
It took until 2008 for certain high-tech industries to exceed unemployment levels before the recession, increasing 4% from 2001 to 2008. The tech industry in Silicon Valley took longer to recover—some companies had to relocate phases of production to lower-cost areas.
Although the dotcom bubble caused stock market mayhem that resulted in the loss of investments and jobs, it did have one specific benefit. The influx of capital within the tech industry contributed to the installation of fiber optic cables throughout the country. This increased nationwide communication and set the infrastructure for many modern tech companies.
One major contributor to the dotcom bubble was the lack of due diligence by investors. Investments in these high-tech companies were highly speculative. People invested without solid profitability indicators rooted in data and logic, like price-to-earnings ratios—some even created unfamiliar quality metrics that were not quantitative. Many investors anticipated that Internet-based businesses would succeed simply because the Internet was an innovation, even though the price in tech stocks skyrocketed far past their actual value.
Undoubtedly, this myopic investing strategy blinded investors from the red flags that ultimately pointed to the bubble’s popping.
What It Means for Individual Investors
If you want to protect your investment portfolio from “bubble investments,” watch out for herd mentality. David L. Bahnsen, founder and CEO of bi-coastal private wealth management firm The Bahnsen Group, told The Balance in an email to be discerning of what other investors say and do.
“When you hear people start saying things like, ‘this time, it’s different,’ or ‘cash flows don’t matter,’ or—my personal favorite—‘valuations aren’t relevant,’” Bahnsen said. “When common sense goes out the window, evidenced by an almost societal conversation, it is a sign [that] trouble is on the horizon.”
To protect yourself from dangerous speculative investments, consider avoiding them altogether.
“Trying to play into a bubble thinking you can time your exit and leave someone else with the hot potato is playing with fire,” Bahnsen said. “If you do not know why you would be investing in something besides ‘Everyone else is doing it,’ or, ‘It’s been going up so I assume it still will’—then don’t invest.”
Instead, rely on reliable metrics to qualify your investment decisions. Bahnsen encourages investors to look at factors such as cash flow, profits, a path to profits, and, among other things, a “balance sheet that can withstand temporary difficulties.”
- The dotcom bubble was an asset valuation bubble that occurred from 1995 to 2000 in which investors poured money into highly speculative Internet-based companies.
- The dotcom bubble peaked when intraday trading on the NASDAQ exchange reached 5132.52.
- The dotcom bubble was largely caused by the lack of due diligence by investors—they invested in Internet-based companies without qualifying an investment with reliable metrics.
- The NASDAQ experienced a more than 50% drop by the end of 2000, leading into the 2001 recession when many tech employees lost their jobs after their employers shut down.