02 July 2015

What the story of Tulip Mania could teach investors today

The humble tulip was once the hottest asset in the western world – and the experience of Tulip Mania holds some valuable lessons for investors today.

If you were planning to plant spring flowers in Amsterdam in early 1637, then you would have had to save up quite a bit if you wanted to include tulips in your garden. In fact, if you were a qualified craftsman earning a decent wage for the times, then you would have needed to put away your total annual salary for 10 years just to get your hands on a single tulip bulb1.

It sounds surreal today, but Amsterdam at the start of 1637 was in the midst of history’s first asset bubble, and the asset getting investors extremely excited was the bulb of the increasingly prized tulip. There’s a (probably made-up) story that one Dutch sailor was thrown in jail after eating what he took to be an onion that he found on his ship. Unfortunately for him, the onion was in fact a tulip bulb – and worth enough to pay the entire crew2.

Why go manic about tulips?

How did tulip bulbs become so sought after, and so incredibly expensive? As with many other investment bubbles (when an asset surges in value by more than is warranted only for prices to collapse later) it had something to do with the thing people were investing in, the people doing the investing – and the structure of the market they were making their investments through.

Tulips were a luxury item – and they had an increasing number of luxury buyers ready to pay for them. A Flemish botanist had started cultivating them for the first time in Northern Europe in around 1593, but since it took between 7 and 12 years to produce a tulip bulb, supply was limited3. The most sought after bulbs such as the famous Semper Augustus, were even rarer, since their blooms got their spectacular marbled effect from a virus that made them even harder to cultivate. 

Those who wanted tulips were competing for a very small number of luxurious flowers. And there were plenty of rich buyers who wanted them. Dutch merchants were growing wealthy on lucrative trade with the East Indies4 and looking to show off their status through planting spectacular flower gardens.

Encouraging speculation

The biggest rise in tulip prices was not in actual bulbs but in tulip 'options'. This was a form of trading contract that gave you the option of buying a particular bulb when it was ready, but carried no obligation whatsoever for you to do so. Historians have argued that it was this, rather than an irrational desire for the best new bloom, that really drove Tulip Mania. It was when the government cancelled these types of contracts that the price of tulips suddenly collapsed.

The real losers

It’s long been assumed that lots of speculators lost huge amounts of money when the tulip bulbs they owned were suddenly worth a fraction of what they had been. However, historians are increasingly convinced that most of the people involved in Tulip Mania lost very little actual cash. Instead, they simply walked away from their options contracts.

The few people who were decimated by the tulip bubble were those who failed to realise what was really going on, who assumed that the value of tulips would keep increasing, and who were confident enough to buy actual bulbs rather than just the option to purchase them in the future5.

What tulips teach investors today

This is the real lesson of the Tulip Mania for investors today. When a particular type of investment seems to increase out of proportion to its obvious value, then it’s vital to ask yourself what’s really going on – and it’s usually a good idea not to get sucked into the bubble that’s being created. Today there are various approaches that can help investors avoid this. One involves diversifying investments and spreading risk so as to avoid putting too much money into one type of asset that seems too good to be true. It might also help to have experts taking charge of your day-to-day investing strategy for you – and this is part of the value that having a fund manager for your investments can provide.

Please note that the value of investments can go down as well as up and you may not get back the money originally invested.

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1The Guardian, Bitcoin hype worse than Tulip Mania, December 2013: http://www.theguardian.com/technology/2013/dec/04/bitcoin-bubble-tulip-dutch-banker
2The Economist, Was Tulip Mania irrational? October 2013: http://www.economist.com/blogs/freeexchange/2013/10/economic-history
3Dash, Mike (1999), Tulipomania: The Story of the World's Most Coveted Flower and the Extraordinary Passions It Aroused
4Ricklefs, M. C. (1991). A History of Modern Indonesia Since c.1300
5The Economist, Was Tulip Mania irrational? October 2013: http://www.economist.com/blogs/freeexchange/2013/10/economic-history

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