Legendary investor Jeremy Grantham, co-founder and chief investment strategist of Grantham, Mayo, & van Otterloo (GMO), is an expert on bubbles, and not the kind you make from dish soap. He predicted two big bubbles in recent history: the dot-com crash in 2000 and the housing market blowup in 2008. Today, he's worried about unwarranted investor optimism in the short term and the economic effects of climate change in the long term. Here's his advice for investors.

1. Practice prudence and patience

In GMO's first-quarter 2020 newsletter, Grantham expressed deep concern with the mismatch between high P/E ratios and the state of the U.S. economy. In his words, "The current market seems lost in one-sided optimism when prudence and patience seem much more appropriate."

Man in suit about to pop a floating bubble.

Image source: Getty Images.

When a guy who's known for predicting bubbles starts talking about "one-sided optimism," that's a signal to rethink your cash strategy and cull risk from your portfolio. First, if you're in or near retirement, check your cash savings and decide if the balance is enough to cover your needs for the next five to seven years. Should a market downturn happen, sufficient cash on hand helps you avoid liquidating when your positions are down.

Then, verify that you're comfortable with the risk in your portfolio. If not, reduce speculative positions in favor of mature, reliable companies with proven track records of powering through recessions and bear markets. Consumer staples and mass grocery retailers generally fit that profile. You know, boring stuff like Clorox (NYSE:CLX), Dollar General (NYSE:DG), and Costco (NASDAQ:COST). Or, if you're not a stock-picker, beef up your ownership of low-cost, broad market index funds. That's an easy path to diversification that provides near-market performance.

2. Recognize your advantage over the professionals

Fund managers are under enormous pressure to create results. That pressure encourages riskier behaviors like frequent trading, speculative buying, and chasing trendy stocks and sectors.

As a nonprofessional trader, you are only accountable to yourself. If you want to build a diversified portfolio and sit on the same positions for 30 years, you can do that. If you want to do nothing when the market goes sideways, you can do that, too. No one will ask you to justify that decision, except possibly your spouse.

According to Grantham, that independence is a luxury and an advantage. Don't waste it by over-trading, reacting to short-term market conditions, or going all-in on the stock your neighbor recommended.

3. Don't put all of your treasure in one boat

Always remember diversification. Diversification minimizes volatility, protects your capital, and gives you multiple pathways to achieve growth and earnings. Keep your portfolio broad, with exposure to multiple asset types, industries, and even countries. You can do that by holding 20 or more individual positions, or by building a portfolio with a handful of mutual funds that each have a unique investment approach.

4. Invest in climate change

Grantham has been talking about climate change for years. In his view, climate change poses a significant threat to the global economy. Investors are wise to hedge against that threat by putting their money into climate change solutions. But Grantham sees other benefits to climate change investing, too. He argues that funding clean energy solutions can generate strong returns, improve diversification, and hedge against inflation protection -- the latter by way of indirect exposure to fossil fuel prices and direct exposure to copper, lithium, nickel, and other clean energy materials.

Notably, Grantham shifted 98% of his personal wealth, some $1 billion, to fight climate change in 2019.

Clean energy ETFs like Invesco WilderHill Clean Energy ETF (NYSEMKT:PBW) offer an easy, diversified entry point to climate change investing. You could also seek out individual renewable energy stocks or companies that have significant initiatives in place to reduce their carbon footprints. One place to start your research is the STOXX Global Climate Change Leaders index, which includes several names you'll recognize, including Apple (NASDAQ:AAPL), Johnson & Johnson (NYSE:JNJ), and General Mills (NYSE:GIS).

Be disciplined and focus on the long term

Even if Grantham is wrong about the state of the market today, it's wise to recheck your cash balances, trim your risk, and improve your diversification. Those steps, along with some exposure to climate change solutions, put you on a good path to ride out short-term volatility and benefit from a longer term global shift away from fossil fuels in favor of renewable resources.