What A Dutchman Buying Tulips in 1637 Has To Do With Your Finances Today

I’m sure that most of you are familiar with the dot-com stock market bubble of the late 1990s, which resulted in a very painful tech stock collapse in 2000 through 2002. Why did that happen? You’ll get as many different answers as you can imagine, everything from “irrational exuberance” to complex explanations of specific stock phenomena. In truth, it comes back to greed and the “herd mentality” of people.

In fact, this “irrational exuberance” has happened over and over again throughout history in all sorts of different investments and financial schemes. And it is here that we meet our tulip-buying Dutchman. You see, tulips in The Netherlands in 1637 were much like tech stocks in the United States in 1999. A single tulip bulb in The Netherlands in 1637 was overvalued to the point that a single tulip bulb sold for roughly fifteen years worth of wages for an average Dutchman, an event called tulipomania. From Charles Mackay’s book on the event (and other interesting ideas), Extraordinary Popular Delusions and the Madness of Crowds:

A wealthy merchant had paid 3,000 florins (note: roughly $125,000 in today’s money) for a rare Semper Augustus tulip bulb, and it disappeared from his warehouse. After thoroughly searching his warehouse, he saw a sailor (who had mistaken the tulip bulb for an onion) eating it. The sailor was promptly arrested and spent months in jail.

Of course, with such madness as this, almost everyone with money began to do the same thingand the vast majority of people who put their money in and did what everyone else was doing lost their shirts.

So what can we learn from this story? Basically, the moral is that following the behavior of everyone else has only one result: serious financial losses. This isn’t merely about stock investing – this philosophy extends into every aspect of financial life. For example, the average American is currently invested in a significant amount of credit card debt, which will only result in them paying out far more money than they take in. Are you going to follow the crowd – or are you going to find your own field of tulips?

This evening, stop by your local florist and look at their tulips. You might even want to buy one as a visual reminder of the fact that it pays to follow your own path.

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  1. Great text. And think that those tulips exist not only where money is the main subject. Whenever there’s a hype, there might be one of those flowers hidden somewhere.

    As said Brazilian writer Nelson Rodrigues, every unanimity is stupid.

  2. phil says:

    Actually, we’re in the midst of a bubble collapse right now: the housing bubble which was driven up by making shaky loans to lots of people who really shouldn’t have been given loans. All those exotic negative-amortization, interest only, ARMs worked when home prices were going up at double digit rates, but now it would appear that the music has stopped in this game of musical chairs.

    At this point 23 subprime lenders have gone under since early December 2006 and now investors are even getting worried about the Alt-A and prime mortgage area. All of this is leading to tightening lending standards which means that people are not able to refi out of their ARMs they took out a couple of years ago. It also means that there will be about 20% fewer qualified buyers in an already slow housing market. Interest rates are heading up and housing prices are heading downward.

    I’ve been following this pretty closely for the last few weeks (prior to that I was actually thinking of buying a house; boy, am I glad I put those plans on hold!). So friends, here you have a chance to watch another bubble collapse very similar to the NASDAQ collapse of 2000. I recommend a few blogs/articles that are covering this:

    http://calculatedrisk.blogspot.com/ (read the comments, great source of info)

    http://ml-implode.com/ (lists 23 subprime lenders who have gone under)

    http://www.safehaven.com/article-6972.htm (gives quick background of what’s happening)

    http://buttonwood1792.blogspot.com/ (all around market info)

    http://piggington.com/ (mostly covers what’s happening in So. Cal, but they’re about six months ahead of the rest of us)

    http://www.housingwire.com/ (mortgage news)

  3. To the bold point of “following the behavior of everyone else has only one result: serious financial losses”, I would be careful about that. The credit card example works, but should I not contribute to a 401K plan with matching funds because everyone else is? Should I not participate in a Roth IRA because everyone else is? Should I get out of get out of stocks and invest in tulips now, because everyone else is in stocks and no one is in tulips now?

    I think the real answer is to evaluate the ideas behind the decisions. It’s easy to see that the math behind carrying a credit card balance is not your friend.

  4. Trent says:

    Lazy Man: the problem is that not everyone else is contributing to their 401(k) or to a Roth IRA. If you really believe that, then you need to expand your horizons a little. For example, I’m the only one of my siblings who is doing it, and my wife is the only one of her siblings doing it. Even scarier? None of our parents are doing it, either.

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