It doesn’t take a genius to be a good investor
And geniuses often aren’t. This summer marked the 300th anniversary of the South Sea Bubble when Britain’s South Sea Company went from £128/share in January of 1720 to over £1,000 by August, and then crashed to £124 by the end of the year.
The most famous person to be caught up in the bubble was Sir Isaac Newton. Widely considered a top 10 mind in history, few have contributed as much to the advancement of humanity. Newton is credited with formulating the laws of motion and gravity. He used his mathematical discoveries to prove planetary motion, explain the ocean’s tides, the earth’s equinoxes, and the shape of the earth. This work helped speed the general populace’s adoption of the sun as the center of the solar system. Newton also made advances in telescopes, thermodynamics, was the first to calculate the speed of sound and he developed calculus.
Despite his unrivaled mind, he was faced with a question in 1720 to which he didn’t know the answer, what to do about the South Sea Company? He had always been a conservative investor with a majority of his wealth in government bonds, and a lesser portion in large companies, including the South Sea Company. As the hype in 1720 around the South Sea Company became unavoidable, he had three choices – sell out, do nothing, or buy more of the South Sea Company.
Come April, a share of the South Sea Company had tripled in value to £340. Newton decided this rally was unjustified and liquidated his position, realizing a large profit. Unfortunately for Mr. Newton the story doesn’t stop there, come June a share had rallied to over £700 and Newton decided he had been wrong. Over the next three months he liquidated all other holdings and put his entire fortune into the South Sea Company near its peak.
The price of the stock collapsed as the market reached a consensus of future profitability that was far below the level needed to sustain the elevated valuation. Investors who had bought on margin were bankrupt and Newton saw his fortune decline by 40% from 1719 to 1721. The unpleasant experience caused him to proclaim, “I can calculate the motions of the heavenly bodies, but not the madness of people.”
In reality, the madness was his own and this was an uncharacteristically human moment for a man whose mind was supernatural. We can learn much from Mr. Newton’s investing errors. One of the problems with market timing is you have to be right twice. He made a sale in April that proved timely but picked the wrong time to get back into the market. Net, net he was worse off for it.
Our cognitive biases and thirst for riches betray the best of us. On average, the wisest course is to stay the course – develop a plan founded in reason and stick with it. The plan should change when circumstances change but not when emotions change. Please reach out to your advisor to discuss chancing life circumstances and how they affect your investment plan – and if you are able to stick with that plan, you’ll be smarter than Newton.