We all love an oul get-rich-quick scheme don't we!? Even if we know it's far too good to be try we will 'click' through or read beyond the head-lines, we just want to know more, 'sure its only looking'.......that is what has you reading this right now! Well I am on a mission to train you out of such inquisitiveness, this is lesson 1!! (and it's totally free!)
Imagine a perfectly sane and prudent nation of people getting swept up into a frenzy of buying, trading and bargaining of a particular item, an item that holds the value of a common flower bulb. Imagine the same frenzy taking hold of an entire nation for over 3 years, eventually resulting in a catastrophic downturn and wiping-out of many many of its' citizens personal wealth and life-savings.
We will explore such an event which happened in the not too distant past, and explore what we can learn from it to protect ourselves from such get-rich-quick schemes in future. (some people have drawn similarities between this event and Bitcoin, we aren't doing that as they are totally different products & we have no idea how Bitcoin will progress, however the behaviour of the masses might not be that dissimilar!).
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The Real Story:
I'll keep this as succinct as possible, but keen to get across the main points and event as they happened. It was over 400 years ago (1593) that a chap from Vienna who was into botany brought a collection of bulbs into Holland. Holland was a very steady, conservative and developed nation at the time apparently, which makes this story all the more interesting!
These bulbs, when planted sprouted an unusual looking flower, called Tulips (we all know them right?). Around this time people would be introducing all sorts of new things into new countries for the first time, however the Dutch took a particular liking to these new flowers. They were reasonably priced, broadly in line with all other flower bulbs, apparently just a little more expensive than others.
It was when these flowers became infected with a virus that caused the flower to become multi-coloured, a mixture of various colours (Mosaic) that the Dutch really started to value them. It became popular to own the most colourful and virus-mottled flower possible. Their social status climbed hugely. Bulb Merchants and importers began to recognise the demand for such items, and so would order in the type of bulb they felt would be of highest demand, and which would therefore secure the highest profit-margin for themselves, quite naturally!
This in turn ensured that the frenzy truly kicked-off, so in 1634 tulipmania set in! As hard as it might be to believe, it became a frenzy. The value which people perceived the tulip to hold rose, therefore the demand for the bulbs continue to rise, while there was only a certain supply of it, and the dealers and sellers had most of them. Naturally demand out-stripped supply, and the price therefore rose continuously (we can see that in housing and anything else operating in the free market). Please bear in mind that these are tulip bulbs we are talking about! Much like commodities last week, they do not generate income or economic growth, they are a product.
The discipline of people who were resisting the temptation to buy into it, and subsequently sell out at a large profit were being tested all the time, the prices kept going up. Imagine yourself in a situation where your friends and social peers are telling you about their recent purchase and swift selling of a flower bulb that has paid for their new 5-series BMW or their extension on their house!!?......You would need to be very disciplined indeed to not jump on the tulip-band-wagon!
Some argue that this period of time was also the birth of leveraged investments, with the 'tulip-call options'. Ultimately this is a means for a hungry investor to get a piece of the action, to speculate, when there are no more items on which to speculate (bulbs were seasonal of course) and with limited money on the table!! Basically, if you had €2,000 but the price of a bulb was €10,000, you would hand over the €2k, in order to buy the option to buy the tulip at a certain point in time. You would not get that €2k back if you did not buy in future. Fast-forward 6 months, and you see the price of a bulb has gone to €20,000. You decide to buy the bulb ('exercise' your option) and simultaneously sell it to the next sucker (fool!) for that €20,000. You have just made yourself €8,000 (price increase from €10k to €20k less the €2k you put down). You have quadrupled your €2,000 investment, with very little work indeed!
We can see that when we are faced with our peers availing of such wonderful schemes as this, that the prices of bulbs has been increasing steadily for several years now that we would indeed be foolish, almost careless and irresponsible, not to avail of this new scheme, surely! This may all seem ridiculous however the madness of crowds is well documented through history, indeed we can see it ourselves over the past decade in several instances.
It all culminated in 1637 with prices increasing 20-fold, for example, from €10,000 to €200,000 in the month of January alone. It is said that around this point people were trading their houses, estates and personal belongings in order to buy a tulip-bulb. A bulb! It was at this point that those who owned them physically or indeed had options on them decided that enough was enough, time to cash their chips/bulbs. This set a snow-ball effect and word spread that it was time to get out of the bulb-game! As you can image the prices then fell dramatically once the fear took hold and madness of crowds took over again, except in the opposite direction! The government jumped in at this stage advising people that there was no reason to fear the prices would fall (essentially that there would be a 'soft-landing' - anyone recall that being said in recent times!).
How wrong they were, February saw the prices plummet over 95% in value. The spiral continued until the bulbs were almost worthless, falling to a point at which one could buy an onion for the same price as a tulip. Which is probably representative of it's true value!
So What Can We Learn From The Dutch Tulip-Craze?
- When we get together with other investors we lose all rationality & judgement. This is not an exclusively Dutch thing, it has shown itself time and time again that we act irrationally when there's a band-wagon to jump onto. We must recognise a short-term frenzy from a truly valuable opportunity for sustained growth, and act accordingly
- Markets Are Irrational. Markets/Investments/Opportunities will fluctuate massively, driven by investor behaviour as well as those with vested interests (bulb-dealers). Having a clear plan and sticking to it will help us avoid such irrationalities
- Keeping up with our peers can be costly. What % of people who bought into the tulips actually wanted to, and what % were doing so as to maintain their status among peers. Indeed, what % of them lost the lot I wonder
- Dabble, if you must. It's great for our retirement or investment pots if we can secure superb growth, but if you cannot resist the urge to speculate then please only speculate on a % of your overall pot that you would be comfortable losing
- Risk & Volatility. This is the greatest lesson we can glean from tulipmania. Risk is the chance of you losing all your capital. Volatility is the rate at which a price rises and falls. There is a huge difference between the two, they are separate factors. The risk associated with investing money on a flower bulb is massive (the chance of losing it all)
- Whats the underlying value? If you invest in S&P Index you are buying parts of businesses which are generating profit, providing services, producing product, paying you dividends. There is an underlying value. if you purchase a property, there is an underlying value to the property itself, aside from the hopefully increasing value. If you are buying a bulb, it too has a value, and not a large one. Consider this before investing in anything I say. The price of an asset has always shown itself to come back to a point which reflects its real value (tulip bulb = onion)
There are probably countless lessons that we can take from the Tulip-Craze, however these are the core ones that pop out and that are relevant to people like you & I as we try to make decisions which will positively impact our financial futures, and ensure we avoid the roasting which many succumb to from such 'get-rich-quick' schemes. You can draw parallels between Tulips and Bitcoins if you like, we can't do that however, because as said above, we have no idea where Bitcoin is going, or indeed what it's underlying value is (which says something too I guess - that episode coming soon!).
QFA | RPA | APA | Qualified Coach