Tulipmania and Modern Investing: Are We Repeating The Same Mistakes?

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The Dutch tulip market bubble, affectionately known as Tulipmania, took place in the 1660s, making it pretty much the first market bubble ever. And as we all know, those who do not know history are doomed to repeat it. So, what can investors learn from this particularly galling market bubble and have we been heeded these lessons in modern times?

Let’s explore this fun, but ominous, topic!

A brief history of Tulipmania

Tulips were introduced to Europe in the 16th century via the spice trade routes. They were unique in appearance to any flower in the region and quickly became a favorite of the aristocratic elite in Dutch society. However, there was also a thriving Dutch merchant middle class that did not really exist in other European societies of the time. This class wanted tulips as well to show that they also were well off. So they became a status symbol.

The problem however is that tulips were very fragile and difficult to grow. This problem began to get solved in the 1600s as growers in Holland developed techniques to grow tulips locally. Now, the flowers could grow from buds from a. mother bulb in one year compared to 7 to 12 years when grown from a seed. So supply grew.

I get it, they’re nice. But c’mon!

Meanwhile, multicolored pattern tulips were developed. Coupled with tulips position already as a status symbol and demand soared.

This is when things got crazy

By 1634, Holland was consumed. Tulips were routinely trading for between $50-150k in today’s dollars. The best of them were going for $1 million in today’s dollars.

So, to put it mildly, the price of tulips was completely divorced from their actual value at this point.

Of course others saw an opportunity to make money. By 1636, regular markets for their sale were established on the Stock Exchange of Amsterdam in Rotterdam, Haarlem, and other towns.

People bought tulips on credit, hoping to sell them for a profit in the future to pay off the loans. Yeah, that’s a really bad idea.

Tulipmania comes crashing down

Tulipmania officially imploded in 1637. At this time, supply of tulips was so much greater than demand that people finally stopped and thought, “Why the heck am I paying this much for a flower?”

Prices plummeted back to somewhere normal.

But a lot of people were in trouble as a result. They had bought tulips on margin and now they had to sell them at whatever price they could get. Which was, at this point, way less than they had bought them for on credit. These “investors” declared bankruptcy and the Dutch economy suffered. Thankfully, it recovered relatively uneventfully.

Actually, some historians now question just how crazy Tulipmania really way, saying it may be over exaggerated. But either way, lessons abound…

What can we learn from Tulipmania as an investor today?

Plenty!

Investopedia does a fantastic job illustrating the lifecycle of a bubble like this:

• Investors lose track of rational expectations (“Tulips are great, their price will always rise!”)
• Psychological biases lead to a massive upswing in the price of an asset or sector (“If I have a tulip too, I can be part of the upper crust. I need one!”)
• A positive feedback cycle continues to inflate prices (Everyone starts looking for ways to make money off of this craze.”
• Investors realize that they’re holding an irrationally priced asset (“Wait…I just paid how much for a flower?!”)
• Prices collapse due to a massive sell-off, and an overwhelming majority go bankrupt

As rational investors, we should seek to avoid market bubbles. We want no part of their rise or ultimate fall.

Why?

Because, while the cycle is predictable, no one can accurately predict when and how the market will actually rise and fall. And if you are looking for evidence to support this claim, look no further than these posts:

• 5 Reasons Index Fund Investing is Better than Stock Picking
• 5 Reasons that Active Investing in Stocks is So Darn Attractive Even Though It Doesn’t Work

As such, if we are investing to grow our nest egg to our goal amount to reach financial freedom in a steady and reliable manner, this cycle is best avoided via a passive investing strategy, largely based on index funds.

Chasing a bubble like this is akin to gambling, not investing.

Therefore, we should do the exact opposite of whatever people were doing during the tulip bubble

Namely,

• Maintaining reasonable and rational expectations
• Actively working to avoid biases like these in our investment strategy
• Diversifying our investments (largely with index funds) to limit an overweighting of any potentially overpriced asset
• Avoiding sell offs based off of mass market behavior

In my opinion, the best way to do this and to avoid the pitfalls of Tulipmania are to incorporate your investment strategies into a written financial plan that explicitly lays out what you will and, just as importantly, will not do while investing.

So, have we learned our lessons?

Absolutely not.

Looking back, it is easy to laugh at our Dutch ancestors for being so foolish. But, in my opinion, a way more embarrassing market bubble grew and popped only a few years ago.

And that is the NFT bubble.

Even as I just write about NFTs, I throw up a little bit in my mouth. NFTs, or Non Fungible Tokens, were, to the best I can tell, unique computer encoded files usually depicting some form of art (cartoon, picture, photograph, event commemoration, etc.) Each NFT was individually and uniquely coded so you owned the only copy. Forget about the fact that anyone could just take a screenshot of the same thing and essentially have the same thing.

In any event, NFTs started popping up towards the end of the COVID pandemic. Stimulus money was flying around and interest rates were dirt low. Everyone saw an opportunity to invest and make money. And someone decided NFTs could be a way to make money. That is stupid enough.

The fact that people bought them for a LOT of money? Stupid beyond comprehension

Thankfully, this bubble popped real quick. Basically as inflation rose and interest rates soared, money got tighter.

As a result, people finally smartened up and started asking why they were spending money on some computer file of a cartoon monkey instead of something with value…any value…because literally everything has greater value than that.

But NFTs remain as a somber and cautionary tale that investors can still fall for the same old (like 1600s old) fallacies and tricks.

So, these lessons are not ones to write off as pedantic or old. A wise investor will still listen to them and pay attention today.

A quick aside on cryptocurrency

I famously just don’t get cryptocurrency. It doesn’t make sense to me. And I don’t see the value in it. As such, I treat it a bit like a tulip or NFT.

However, I recognize that I am in the minority here. And I even recently admitted that I may be wrong. Either way, it has not changed my written financial plan.

And if a crypto bubble does pop, I’ll be here to say I told you so.

In the end, I don’t really want this to happen. But I do worry about those with overloaded crypto holdings in their portfolio. So, if you are one of them, maybe just consider Tulipmania for a minute? Please.

Tulipmania and Modern Investing: Are We Repeating The Same Mistakes?