Selfish History

Prologue: Disappointment Comes Mighty Hard

George Mehales was quietly building a life for himself. Born in Greece, his mother thought to give him a name that would blend in when called into the New York air which, by the time of the Roaring Twenties, was thick with prosperity and potential.

‘You’ll get rich in America someday’ she said. In 1929, when September yielded to October, he just might have believed her.

George owned a cafe in New York – and business was good. Social spaces such as these are supertransmitters for the word on the street, and talk was anyone with a few spare dollars would be a fool not to plug it into the market. Indeed, consulting a historical graph, the peak formed over the 1920s is the Everest of the economic range up to that point.

It is at the final approach to this very precipice that George began ploughing his earnings into the market. His debts, he thought, could be covered at a later date. The market would soon dismiss them from the realm of importance. 

October 29th 1929. George, despite efforts to close his position or stem his losses with an offsetting transaction, is wiped out. Soon after he is forced to sell his beloved cafe for a pitiful amount in order to alleviate his debts. His is one of the swathes of budding American dreams now wilted by the Roaring Twenties’ failed harvest. 

‘I guess disappointment comes mighty hard to some people, but that almost killed me’

                         – George Mehales, 1938

Introduction: Applying the Basecoat 

Stories of destitution following market crashes are something which many assume will befall them. Actually, if you fall in this group, you are most likely correct to some extent. The overwhelming chances are that if you invest in the market and expect to live for a few years yet, a correction will hit your investment portfolio. 

It need not be the deterrent it may appear. If, as the horror stories state, a 90%+ collapse in global markets occurs this is likely the least of your worries.

Genuinely, it may not be the end of the world unless it really is the end of the world. I’d wager it a safe assumption that, in this eventuality, reviewing your pension is somewhere on the list of importance alongside rescheduling your upcoming dentist appointment around the collapse of modern civilization. 

Perhaps you think I’m painting too simple a picture here, using broad strokes and operating a fluffy-clouds-only policy when it comes to illustrating stock markets. If so, make no mistake: bursting bubbles and steep corrections can be – have been – the destructive toddler wrecking many attempts at sculpting a financial future. 

My central argument in the following piece, merging shades of history and finance, is to simply stand back and watch the paint dry. 

You see, the inevitable crash will most likely come, and I hope to bestow you with a historical seatbelt of sorts. A staunch strap that protects from any unnecessary acts of defenestration via the windscreen when it comes to your financial plans (or yourself for that matter). 

Let’s start with historical examples which function as useful microcosms to the wider notion of the ‘market crash’. By the end, we should have a greater understanding of what they are, how to navigate them, and why (with the correct, informed, approach) you needn’t lie awake at night worrying about them. 

Think of it as the financial version of looking in the wardrobe and seeing there is no monster. 

***

Wikipedia tells me an investment is a ‘commitment of resources to achieve later benefits’, which I find appropriately vague and correctly holistic. If you live in a society like mine, it is both a blessing and a curse to have such a diverse warren of investment pathways available, all gesturing excitedly at our wallets. 

Retro cars, limited release trainers, precious metals, questionable artwork, whiskey old enough to claim a state pension. All are bonafide investment opportunities. These can be entertaining, conversation-starting acquisitions.

However, an alternative view is that the investor is essentially backing that vintage bottle of red to outperform all other asset classes worldwide. Unless you are a true connoisseur, it is comparable to putting it all on a different kind of red…

Because price can be distilled into a reflection of supply and demand, when a great many people catch investment fever for a particular asset the price begins to become inflated (like a bubble). This bubble often reveals itself only for the grand finale: the pop. 

One of the most famous bubbles in history requires us to return to a familiar setting from my last post: the Dutch Golden Age. It might seem a peculiar story, a cautionary tale for only the least financially savvy.

Contrarily, it introduces the very important topic of diversification and how this functions as a shield against bubbles and sector crashes. Moreover, I would be surprised if some of today’s quirkier investment opportunities were not looked upon similarly in decades to come – if they are not done so already. 

Tiptoe Past the Tulips 

You may have encountered the term tulip mania. It has become a byword for ‘asset bubble’ and is likely the first widely-reported example of one known to history. If someone accuses you of holding tulips they aren’t complementing your green fingers – it means your asset is, in their eyes, overinflated. 

When tulips began to spread around 16th century Europe  – one of many exports from the Ottoman Empire, including war, in this time – they were quickly identified as unlike anything before cultivated. The first seeds to make the trip to Vienna from the Ottoman court are said to have been sent by an ambassador: Ogier Ghiselin de Busbecq. (I’d like to think Sulieman the Magnificent agreed to sending them flowers as a belated, touching, apology for sieging Vienna in 1529.)

Regardless of their source, the Low Countries embraced this vibrant new flora that spread westwards. Tulips were soon vaunted as status symbols, pretty emblems of the now-flourishing Dutch Golden Age. Those who grew the leafy investments soon began to market their varieties with grandiose titles which only increased demand for bulbs.

The formation of what would become a fully fledged market for tulip bulbs can be traced to the manner in which bulbs were traded – a method called ‘forward contracts’. This worked by ironing out the price for the tulip long before it bloomed; the out-of-season period for the blooming itself was in fact the time when buyers were securing their future flowers. 

The forward contracts that underpinned these tulip orders were somewhat archaic. It is enough to know that these tulips – which by the early 17th century were selling each for the equivalent to buying a piece of Amsterdam’s real estate – were not purchased on a firm, regulated footing. Tulip growers would soon come to rue these forward contracts, as they were no less delicate than the petals they represented. 

February 1637. The tulip market has finally wilted. The immensely overinflated bulb price now made acquaintance with its long-estranged intrinsic value.

While stories of people throwing themselves into the canal and being forced onto the streets (with nothing but a flower in their cap, no doubt) are not supported by most historians, there was a key loser in the fallout: growers. Their woes are centred on those forward contracts. 

Under the forwardly purchased method, money wasn’t due to be exchanged for flowered bulbs until Springtime. Those who agreed to purchase tulips months before now refused to follow through with extant contracts, which by February represented figures multitudes more than the current price. 

And they could do so too: there was no legally enforceable wording inserted into the primitive contracts that meant buyers had to pay growers. Courtrooms were soon filled with furious floriculturists looking to get their payouts from pre-bubble bulbs. 

In the end, the majority of contracts were not honoured in full. The legal fallout was years-long and no blanket ruling was made. In many cases, a small fee could be paid to tear up the contract, this and others were essentially a retrofit of these forward contracts into ‘options’ contracts. 

The tale of the money gained and lost in this period of tulip mania certainly holds all the fundamental components of bubbles since, laying out the blueprints for future disasters. The danger of pouring your money into specific, narrow, assets and being fuelled by speculation is indeed here laid bare. 

As we know, this may be one of the first documented examples of the market bubble but it is certainly not the last. It is difficult to identify a period when certain assets and trends are not being labelled as being in a bubble, and it can be immensely stressful to keep track of when to pull out of the market if a crash is anticipated. 

Those who feel the pop of the bubble, such as this flower-powered one, most can often be identified as lacking one key attribute in their portfolios: diversification. Moreover, falling into the associated mania around what is often an incredibly exciting trend is another foible all too common in ‘embubbled’ victims. 

Which do you believe, over a course of multiple decades, will offer the best return: chasing the latest craze (Pokemon cards, NFT’s, dare I say the latest untested cryptocurrency) or the collective global market, responding to ongoing human innovation and progress? 

Planting a few tulips into your investment garden is fine, even fun. The issue lies in becoming blown away by a bubble you are not protected from. Diversification can help to navigate individually volatile investments, affording a piece of mind that prevents a need to stress constantly over when to pull out – or else. 

Perhaps the easiest way to achieve diversification is a low-cost global index fund, tracking up to 1,000s of companies at a time. Many seemingly volatile bubbles can go unnoticed here and the ‘largest’, at least to those exposed, appear somewhat less dangerous. But what happens when the entire market collapses? How can you avoid the all-encompassing bubble?

Unless you are very lucky, you can’t and, in some ways, you shouldn’t either. 

A Crisis Unrealised: Staying Put 

In a crisis, it is generally human nature to act. Flight and fight may seem polar opposites, but both are antonymous to immobility, passivity even. It is what makes inaction around a market crash so confusing a practice to grasp, let alone employ in a real scenario. 

It is difficult to imagine someone being better off staying in a sinking ship or turning their noise cancelling on to drown out an earthquake. However, with a diversified investment portfolio reflective of your personal risk tolerance, what I previously referred to as ‘watching the paint dry’ is an approach I hope to champion in this section. 

There is generally a lot of worry when it comes to discourse around the stock market and how to manage one’s investments. Worry about when to invest, how much and into what, when to pull out and when to re-enter again. It sounds like an exhausting cycle.

And it isn’t helped by the investment media treating every minor dip like an insidious portent. (Headline: Oh no! Your investment you aren’t planning to access for 30 years has fallen a gigantic 5% on Tuesday – didn’t you see?!)

Historic data around market bubbles makes one thing clear: don’t try to time the market. Most who attempt to avoid these plunges miss the positive bounceback and serve only to crystallise their existing losses which aren’t truly real until that sell button is pressed.

In fact, those emerging best from the (so far) inevitable market recovery are the individuals who hunkered down, sold nothing, and kept investing along the way. Those who withdraw so often miss the biggest recovery days – and even being uninvested for a handful of these hampers your market re-entry and overall portfolio recovery.

Let’s illustrate the above with some of the 21st century’s bubbles and crises (of which we know there are more than a few). The period of 1999 to 2018 saw its fair share of economic troubles, from the dot-com bubble to the global financial crisis. Surely not reacting to any of that would be a fool’s game?

Well, JP Morgan tracked fictional S&P 500 (an index of the USA’s 500 largest stocks) investors who each started with $10,000 at the turn of the millennium. The investor that reacted emotionally and withdrew their money at any semi-plausible market downturn – in this case categorised as missing the 30 best market days each year – ends 2018 with a measly $6,217. The investor who simply left their $10,000 in pasture finds themselves with almost $30,000 by that same date, global financial crisis included. 

A breadth of similar analysis exists and most equates attempting to time the market to selling low and missing the best of the recovery. (Even the investor who missed only the 10 best days per year ended up with less than half the amount of our set-and-forget hero above.)

It introduces us to an old adage: time in the market is better than timing the market. In other words, slipping into a coma for a couple of decades is probably the best financial decision you could make. 

An Attitude-Adjustment to Risk-Adjustment 

But what if we are forced to sell on account of needing that money? It is an unfortunate position if, despite knowing all of the above, you still have to sell in order to maintain your quality of life, cover debts and generally survive. I chose to highlight George Mehales’ story in the prologue not for his extraordinary bad luck, but for the sheer commonality and unremarkableness of his predicament. 

A rule of thumb rammed down the throats of anyone who has consumed investment media is don’t invest more than you can afford. Having all of your accessible funds in the market is asking to be stung upon withdrawal. 

Once that is down, and a cash emergency fund is improving your quality of sleep exponentially, we can have an introspective chat with finance’s Tweedledum and Tweedledee: time horizon and risk tolerance. 

***

The simple fact is that money in the market needs time – lots of time. Being fully exposed to global equity is acceptable when retirement seems a distant dream. This is because young investors are able to ride out plunges in their accounts knowing they can weather the storm for years if need be (while buying in nice and low along the way, I might add). 

However, those of us with higher mileage on our investment vehicles must consider needing that money soon, especially as pension accounts become legally accessible. Generally, tolerance to risk should gradually decline until retirement, which means assets are required to slowly steer to being less volatile as one’s time horizon shortens. 

Probably the most common method to achieve this is gradually swapping equity investments for the purchase of bonds. The dull reputation of bonds, which are probably the cardboard of financial packages, should get any short-term or otherwise risk-averse investor very excited indeed.

And so it is that with a risk-adjusted portfolio, and a stern self-warning against emotional decisions during market downturns, bubbles have the exact effect that you have personally planned to let them have.

I appreciate we are now a fair distance, both in investment approach (good) and in scope, from Dutchmen flippantly buying tulips. So, let us try and build an actionable conclusion based on the above, before diving into some further reading. 

Bubbles? They’re Blown Out Of Proportion 

A few key tenets of [my personal approach to] prudent investing have been addressed above. Firstly, we touched on diversification. This is important both across asset classes (spreading over equity, bonds, commodities ect) but also within classes.

In this case, large-scale index funds offer the best diversification in equity markets – and therefore the best protection against bubbles which are, shall we say, often regional in their effect. 

Therefore: a diversified portfolio is good investment practice and protects from bubbles stemming from individually overpriced sectors and industries, fuelled often by speculation. 

Next, we rescinded control over the belief bubbles and crashes can be avoided. This was in fact flipped on its head through presenting simple inaction as possibly the best practice. Riding out these choppy waters much more often than not results in better long-term growth and locks in all of those lovely gains on the rebound. 

Therefore: your diversified portfolio is likely best left invested (and continued to be invested in) throughout difficult market periods and financial crises. 

Now that we have our investment approach and emotions in check, we were able to proceed into the realm of personal circumstances. This began with investing holding an appreciation of not needing that money for at least 5-10 years (enough time to combat short-term market fluctuations). Your cash savings account isn’t going to crash 20% overnight, and so it is recommended to keep money needed within a shorter period out of the markets. 

Lastly came the need to risk-adjust one’s investments depending on the proximity to needing that money. In other words, a market correction for the young is an opportunity to buy low, but a life-changing event for older individuals too exposed when approaching drawdown. (The latter is a tale found through history and was an especially grim outcome of the 2008 global financial crisis.)

Therefore (deep breath): Diversified portfolios, protected from bubbles and left alone during downturns, need to be adjusted depending on the investor’s risk tolerance and time-horizon, and be backed by cash funds which prevent forced liquidation during inopportune moments. 

Anyway, here’s a book. 

Selfish History’s Book Recommendation

Boom and Bust: A Global History of Financial Bubbles by William Quinn and John D. Turner

If, like me, you are a veritable joy at parties due to a keen interest in both history and finance, then this should be a great read. As the authors address bubbles throughout history, it becomes clear that the central components remain ever-similar. 

Bubbles, as I’ve briefly touched upon here, are so often fueled by hype (or whatever the 1800s equivalent is – razzmatazz?) and lead to overinflation of an asset’s price. As well as the author’s insightful and heavily informed teachings, keep in mind the outcomes of this post during reading. 

I am willing to bet the portfolio and approach we finished with can take on anything Quin and Turner’s pages can throw at it.