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Investing Lessons from Market Bubbles

We all know that money plays on emotions, and that emotions drive behavior. And it says a lot about this very fact when the scientist responsible for the law of gravity can be swept up in an investment that for a time, defied the laws of science. Sir Isaac Newton may have been one of the most gifted minds in the scientific community, but in his day to day life, he wasn’t much more than a gullible participant in one of the biggest market bubbles of the early 1700s.

Even Smarties Can be Suckers

No matter how advanced your intellectual capabilities may be, there is a sobering fact that unites investors everywhere: We’re suckers for a good get rich quick strategy. Throughout history, financial bubbles have tugged at the cords of greed, seducing investors with their promises of instant gratification.

The bubble that got Newton was the South Sea Bubble of 1720. It was centered on a company that was promised a trade monopoly by the British government for taking over the debt that was the result of the war against France. The investment grapevines blazed and the press continued to fuel the fire. The South Sea Company shares grew almost eight-fold between January and mid-July 1720. But just as all good things come to an end, the bubble burst in September of that year. By October, share prices had dwindled to their January price.

So what does Newton and other investors from the South Sea Bubble have in common with investing victims of modern day bubbles? Quite a bit according to Richard Dale, a London-based economist, author and historian.

Investing Lessons to be Learned from Market Bubbles

Dale recently gave an interview to MarketWatch where he points out investing lessons from the South Sea bubble that can still apply to the modern investor/market bubble. Here are a few of them:

MarketWatch: How did Isaac Newton get lured into such a disastrous investment?

Dale: Newton invested around £3,500 in early 1720 and sold out in late April of that year having doubled his money. However, like so many others, he was induced to get back into the market in the summer of 1720 at the height of the bubble and ended up losing £20,000, around £3 million in today’s money.

MarketWatch: What modern-day financial bubble is most similar to the South Sea Bubble?

Dale: From the standpoint of the South Sea directors, the bubble represented a giant Ponzi scheme (e.g. Bernie Madoff) in that it proposed to pay dividends not from profits but from sales of new shares for cash. From the point of view of investment behavior, the bubble resembles the boom/bust when the valuations of companies lost any connection with underlying value or realistic profit projections. (The Bank for International Settlements pointed this out at the time). I don’t think much has changed. Bubbles are inherently instances of how crowds can go crazy.

It’s exactly the same mentality. ‘You gotta play the game while the game is going on.’ The fear of losing out and losing market share, that mentality of knowingly taking some pretty big risks because everyone else seems to be doing the same, seems to be a feature of markets from time to time.

MarketWatch: So it is pretty easy to get sucked into a bubble?

Dale: I think even way back in 1720, the people that got sucked in, in many cases, were very ordinary people. You didn’t have to be rich. Mini bubbles were developing. It was the poor man’s bubble. For a penny you could buy a share subscription. Everyone was being sucked in at that time…I think one of the features today is one of the ordinary returns from conventional safe investments is now so low that people are inclined to look for riskier alternatives.

MarketWatch: What are signs that an investor is involved in a venture that could end badly?

Dale: There are different things…It’s painful to watch when people are offered higher-than-normal returns, and higher returns than you could reasonably expect. They tend to fall for it time and again. That happens and people lose their money. You only offer supernormal returns if you’re offering supernormal risks.

What we’re seeing all the time with these is that …investors are offered good returns when good returns are hard to come by. That’s not going to change…Madoff was a slightly more sophisticated one because returns were not that out of the ordinary. That kind of thing is just going to go on and on. People are greedy and will jump at the prospects of better-than-normal rates of return.

MarketWatch: What else drives people to get involved in risky financial ventures?

Dale: In some cases, it is the desire to be brave and do something different, the excitement. Or it is a retired person wanting to do something interesting, make their lives rather exciting…high risk, high return. There are plenty of savvy investors who are prepared to take a high risk, but once you get to a certain stage you don’t need to do that. Some people just don’t know they’re taking the risk…a lot of people are very financially naive. It is unfortunate, but that is the case.

Why Does it Matter to You?

At their core, market bubbles from all time periods have the same effect on investors: They convince them they’re onto something groundbreaking only to have it blow up in their face. A good way to avoid being swept up in the market mania is to create an Investment Policy Statement.

This statement will guide how you invest by aligning your money with your values and goal for reaching your full financial potential. If an investment doesn’t match the criteria of your IPS – which many found in market bubbles won’t – then you shouldn’t invest in it. Period.


There are many other areas to consider but most people ignore these. If you need help designing your plan for retirement or just a second look, we’re happy to help.

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