By: Joe Delaney
If you were to spend thousands – perhaps even tens of thousands of dollars – on the bulb of a flower that blooms for just one week per year, would your friends think you were crazy?
They wouldn’t if you lived in Holland in the early seventeenth century. At that time, the Dutch were trading tulips for many times more than a craftsman could make in an entire year. Tulip traders could make in a couple years what it previously took the richest families in Dutch society to amass over generations.
All because the tulip market said that’s what these flowers were worth. For a while, anyway.
It Couldn’t Last Forever
The tulip was already a status symbol in Holland by 1634 when speculatorsentered the market to buy and sell for quick profit, or “flip” the flowers as people in the housing market do today. The demand was so great that cultivation of the flower, which takes seven to 12 years to grow from seed, couldn’t keep up. In 1636 the Dutch created what would today be called a futures market in which contracts to buy bulbs at the end of the season were bought and sold.
There was no longer even a flower changing hands, just a piece of paper.
By the winter of 1636-1637, tulip prices had swelled to 60 timeswhat they had been just three years earlier. Even more remarkable, the value increased twentyfold in just a single month leading up to the breaking point. On February 5, 1637, a buyer defaulted on a tulip bulb contract at a routine auction in Haarlem, triggering a crisis of confidence in the market that led to its quick demise.
A few days later, tulips were worth a hundredth of their former prices.
What We Can Learn from Tulipomania
While historians and economists debate the causes, depth and breadth of the “tulip mania” of 380 years ago, the event remains a vivid illustration of the lure of economic bubbles and the pain they cause when they burst.
1. Sometimes common sense is not so common.
On February 6, 1637, people woke up to realize they had traded their homes for not even a beautiful, bloodred flower; just the option to buy it once grown. How had they not realized their folly before this?
In a modern word, FOMO: fear of missing out. When we are surrounded by well-meaning people telling us we ought to get in on something good or we’ll miss out, it’s easier than we think to dismiss our better judgment. The market says this is extremely valuable, we think, so it must be.
But the market can be an unthinking mob, and a flower is just a flower, however beautiful. We must never forget that when we are thinking of betting our fortunes on a fad.
2. All good things come to an end, some faster than others.
That said, it is hard to argue against the value of real money one makes from the purchase and sale of a product rapidly rising in value (be it a security or little brown bulb). You could easily argue that it would have been folly for the Dutch traders notto participate in the tulip market to some degree.
This is where it gets tricky. It makes sense to engage in growing markets, and it is next to impossible to recognize a bubble except in hindsight. We don’t have crystal balls. How can we turn off our FOMO in time to pull ourselves out of the thrill of rapid gain before the tides turn on us?
3. The only defense we have is a strong plan and a determination to stay the course.
The best solution we have as flawed human beings is to install circuit breakers into our future investment activitybeforewe become drunk on manias like the Dutch suffered four centuries ago. This is the first, vital function of a financial advisor: to help investors make a plan that determines in advance how much risk is acceptable and how much gain is reasonably attainable.
The second vital function is to advise clients to stay the course through feast or famine.A properly diversified portfolio of investments will not be dependent on the rise and fall of fads in isolated markets.
If Lifeguard Wealth had been around in Holland in the early seventeenth century, we’d like to think we would have said the following to our clients:
“Of course we’ll take a look at the tulip trade. But first, let’s take a look at your plan.”
By clicking on any of the links mentioned above, you acknowledge that they are solely for your convenience, not required to click. They do not necessarily imply any affiliations, sponsorships, endorsements or representations whatsoever by us regarding third-party Web sites. We are not responsible for the content, availability or privacy policies of these sites, and shall not be responsible or liable for any information, opinions, advice, products or services available on or through them.
The opinions expressed by myself and other featured authors are their own and may not accurately reflect those of Lifeguard Wealth. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.
© 2018, Lifeguard Wealth